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Market Wrap

Pause to Reflect

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      11-11-2003           High     Low     Volume Advance/Decline
DJIA     9737.79 - 18.70  9761.20  9719.05 1.43 bln   1291/1892
NASDAQ   1930.75 - 10.90  1944.01  1923.50 1.63 bln   1088/2051
S&P 100   518.66 -  0.11   519.58   517.11   Totals   2379/3943
S&P 500  1046.57 -  0.54  1048.23  1043.46 
W5000   10194.56 - 20.40 10221.12 10167.22
RUS 2000  528.57 -  4.64   533.42   526.76 
DJ TRANS 2927.24 - 52.10  2963.76  2935.28   
VIX        17.54 -  0.08    18.53    17.50
VXO (VIX-O)18.00 +  0.05    18.53    17.86
VXN        26.55 +  0.06    26.99    26.54 
Total Volume 3,294M
Total UpVol  1,116M
Total DnVol  2,099M
52wk Highs  281
52wk Lows    25
TRIN       1.11
NAZTRIN    0.96
PUT/CALL   0.96

While the country paused to observe Veterans Day the markets paused to reflect on direction. Volume for the last two days has been very low with Monday failing to break three billion shares across all markets. There were no material economic reports and no material news. However, there was a material change in the market internals.

Dow Chart

Nasdaq Chart

The only economic report was the weekly Chain Store Sales and the number showed a significant +1.2% bounce. This was the largest gain since +1.3% on Oct-4th but barely enough to recover the drain over the last four weeks. The cold weather finally appeared and drove shoppers to the stores to buy more seasonal clothing. However, the Bank of Tokyo lowered their estimates for the month to +4% from +5% based on the overall trend. Retailers are still expecting a strong holiday season but price competition is going to be tough. The price wars online have already started and profits are going to be hard to capture.

Since the markets were not moved by the numbers there was another factor at work. The mutual fund cloud appears to be growing and that worry kept the normally bullish holiday in the negative column. According to Putman they suffered -$14 billion in mutual fund outflows last week. This was more than the -$10 billion previously reported and in addition to -$9 billion in withdrawals on other managed assets. This is a major hit to Putman in the range of about -5% of their fund assets. Typically some funds keep 2% to 3% of their assets in cash for redemptions and buying opportunities. This was about twice their cash held in reserve. Alliance funds also said they saw -$14 billion in withdrawals last week.

A Morningstar spokesman said they had talked to several fund managers at Putman and they confirmed they were selling stock to raise cash. How they were selling differed among managers. Some were selling a "slice" or a percentage of everything in the portfolio and others were just liquidating stocks they no longer wished to hold. Since Putman is generally a large cap fund family you only need to look at GE or MSFT to see some selling pressure. Contrasting them with MMM and INTC you can see that the weaker of those are being dumped while the stronger earners are fairing better. It is not that GE and MSFT do not produce strong profits but they both had some qualifications in their earnings that caused analysts to expect less growth in the future. Plus, they are the biggest and most liquid large caps. Funds can get out easy and not ripple the market. Also, funds seeing a cash drain could continue to sell into any bounce to raise additional cash for future redemptions and to replenish their normal cash reserves.

Adding to the fund problems were comments today that the founder of the Strong funds could be subject to criminal prosecution for market timing his own funds for friends and family. He created an additional $600,000 profits from the trades and has volunteered to repay anyone that was harmed by the process. What is harming investors is the constant stream of bad news about these funds under fire. The Gallup organization ran a poll in the last week of October and before the latest volley of bad news. They found that 51% of investors with money in funds would probably withdraw their money from any fund with problems.

The bright side of this equation is these investors are pure stock investors and that money will be put back to work in other funds relatively quickly. Funds benefiting from the switch are Fidelity and Vanguard which have not been charged. Conflicting fund flow data also appeared today. AMG Data said that $24 billion flowed into funds in October. This was more than $17 billion that TrimTabs had estimated just last week. We have seen this in the past as each firm calculates the numbers differently. The numbers for November are sure to be even more confusing as investors shuffle record amounts of money into different funds.

Another worry is that funds under attack or expected to come under attack could start looking at locking in their gains to produce strong year end ads in order to rebuild their image. This could produce selling into any bounce to try and maximize gains.

Other worries are slipping through the markets. There is a persistent rumor that Greenspan could make a preemptive strike and raise rates 25 points at the December meeting. The move while miniscule would signal an end to the neutral bias and show that the Fed was ready to attack the coming inflation flu. Personally I think this is pure bull and not worth a honorable mention but it is making the rounds. The reason I do not expect any Fed action other than maybe a bias change or the removal of the "considerable period" clause from the statement is due to the lack of a recovery. Yes, I said it but it is not what you think.

The official estimates for the 4Q GDP are hitting the wires again and they range from +3.9% to +4.0%. But the estimates for the 2004 GDP have been raised to +4.2%. You were expecting more? Forrester Research announced this week that IT spending for all of 2004 is only expected to grow +4%. They said they expect companies to remain cautious until the recovery is well under way. Once the rate hikes start there is likely to be a period of consolidation and hesitation until we see if the hikes kill the recovery. More bull since all recoveries are accompanied by higher rates but that is another story. What will slow the markets is ten year rates over 4.75%. This is the level where conservative funds can feel comfortable switching from risky stocks to safe bonds.

The problem it appears is the validity of the GDP numbers for the 3Q. There are different trains of thought on why the GDP numbers were so high. The general consensus was pumping of autos at little or no profit to keep the pipelines moving and the continued activity in the housing sector. I suspect it may be a little more basic than that. If you remember the Retail Sales for September were +5.9% and everybody was bragging about how fast the consumer was ramping up. This followed a hot August pace at +5.1%. Most people do not realize that merchandise for the coming holidays must be ordered 3-6 months or even more in advance. The drop dead order date for most merchandise is the end of August or early September. With the lowest inventory to sales levels on record and a strong ramp in August and September the urge to order holiday merchandise was probably strong. How much of this holiday ordering impacted the 3Q GDP is unknown. What is known is that any holiday orders that contributed to the +7.2% GDP surge are now history. That merchandise is either in stores or will be in stores over the next week to take advantage of the Thanksgiving shopping spree. This means there could be a pause in orders and production for consumer goods until retailers see how the holiday season progresses. It could also mean that the November jobs report could show a loss of jobs once again.

The true test will be the 4Q-GDP, which is not announced until late January. We also need to see if the job growth sticks or whether that was a one time bounce. We will see the Nov. Jobs on Dec-5th. With the next Fed meeting not until Dec-9th it is far too soon to start worrying about a preemptive rate hike. Anybody that thinks they know Greenspan's next move in advance is on drugs. While he will want to be on the lookout for the inflation flu it is not even a remote risk at present. He can do more to further the recovery by sitting on his hands than by trying to micromanage the bounce. He is widely credited with killing the last bubble so I doubt he wants to step in front of the canons again so soon.

Despite the minor sell off of the last three days the market sentiment is still very bullish. Only today did the internals begin to show weakness but on holiday volume it would be tough to draw any conclusions. About the only fly in the long term ointment is the vast discrepancy between insider buying and insider selling. According to Thompson Financial there was only $52 million dollars of inside buying in October. This is not even a drop in the bucket much less bullish confirmation of the future economic outlook. They also show that insider selling was exploding with $59 of insider selling for every $1 of insider buying. This is the WORST ratio since records have been kept. (15 years) This is a long term sentiment indicator that has proven accurate in the past.

A short-term indicator is the number of new highs/lows. The number of new highs topped out in the recent rally at +1172 on Nov-3rd. They eased off slightly and then rebounded to 1066 on Friday. Monday there were 600 and today 281. While this is a significant drop both Monday and Tuesday were very low volume days and are not statistically valid. Should the volume pick up on Wednesday as expected and the numbers continue to decline then it would be very negative. The VXO spent most of the day over 18 due to three days of light selling but fell back under 18 just before the close. Despite the selling there is still no fear in the markets.

Earnings are still in progress with over 200 late reporters due out in the next three days. JCP fell today after announcing a -56% drop in earnings due to losses at its Eckerd Drug Store chain. ANF dropped -2.5% after the bell after announcing a drop in same store sales of -9% and warned that the 4Q sales could be flat. They guided analysts to 93 cents for the 4Q and that was less than the $1.00 that was expected. AMAT announces on Wednesday and WMT and Dell on Thursday. CSCO gave cautious comments at their shareholder meeting and said that customers remain extremely conservative despite the apparent recovery in progress. Chambers said this was the least "risk taking" environment he had ever seen. He also said he was only cautiously optimistic that the telecommunications sector was rebounding. Not a very cheerful overall outlook. Adding to the gloom was a serious drop, -303 points, in the Nikkei last night to punctuate a -1000 point drop in the last three weeks.

To recap all the above we have verified selling in mutual funds, unverified rumors of a preemptive rate hike, heavy insider selling and disappointing results by JCP and ANF. CSCO appeared to be backing up slightly and the Nikkei is imploding. Despite all the bad news the Dow is only down -115 points in the last three sessions. The Nasdaq is down -46 points. This is hardly a sell off or even light profit taking. Now that the jobs report has passed traders appear to be just taking a breather. The two-day holiday and that is what it was if you look at the volume, was a chance for everyone to step back and look at the picture and decide what they are going to do over the next six weeks. Six weeks! That is all that is left in this year. Do they keep them and hope for the rally to continue or do they sell them and chalk up huge gains. Based on the minimal reaction to nearly $30 billion in fund withdrawals I would say the plan was to hold and hope for more.

The next three days are going to be critical. Monday and Tuesday were throwaways due to the holiday. Friday was also in that category because of the job shock. Now all the news has been digested and the direction we take between now and Friday could be our direction for the rest of the year. The lack of material selling could be a leading indicator but there are very strong opinions on both sides. Watch the internals the rest of the week and hope for strong volume. The bulls need for the new highs to break 1000 again and the advance/decline volume needs to be better than 3:1 in favor of advancers. If we get that then we might get another chance at Dow 10,000. If we get 3:1 down volume on more than four billion shares then it may be time to step aside.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
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