Option Investor
Market Wrap

Warning Season Begins

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      12-04-2003           High     Low     Volume Advance/Decline
DJIA     9930.82 + 57.40  9933.86  9865.78 1.84 bln   1563/1620
NASDAQ   1968.80 +  8.60  1971.25  1942.67 2.11 bln   1436/1748
S&P 100   527.56 +  3.14   528.01   524.42   Totals   2999/3368
S&P 500  1069.72 +  4.99  1070.37  1063.15 
W5000   10431.96 + 29.60 10437.68 10362.72
RUS 2000  544.15 -  1.04   545.89   537.23 
DJ TRANS 2938.02 -  1.50  2944.22  2914.20   
VIX        16.30 -  0.33    16.83    16.29
VXO (VIX-O)16.56 +  0.26    17.37    16.50
VXN        26.81 -  0.53    27.45    26.70 
Total Volume 4,264M
Total UpVol  2,195M
Total DnVol  2,018M
52wk Highs  444
52wk Lows    25
TRIN       1.05
NAZTRIN    1.11
PUT/CALL   0.72

It was a strange day in the markets with the opening bounce fading midday and taking the indexes down to initial support before a series of buy programs in the last hour rescued the bulls from a dismal fate. That rescue ran into trouble after the close with warnings from two companies that tanked the futures in the overnight session.

Dow Chart

Nasdaq Chart

Russell-2000 Chart

The bad news started early with a jump in Jobless Claims by +11,000 to 365,000 and an upward revision to last weeks numbers to +354,000. It was not a material bounce but we all know how traders count on new trends continuing. The two consecutive weeks of declines gave traders hope and the return to early November levels weakened those hopes. If the Nonfarm Payroll report was not tomorrow I do not think traders would have been so nervous. Continuing claims also rose to 3.38 million. Actually the internal numbers were great. 47 states and territories reported a drop in claims while only six reported increases. The overall decline in claims may have unintended consequences. It appears now that lawmakers will NOT vote for a fourth extension of benefits and that means over a million more workers will no longer have any unemployment income. This could further depress the retail sector as those on the bubble tighten their wallets even further.

Also depressing sentiment was the lighter than expected Retail Sales for November. The monthly sales came in at +3.6% and slightly below already lowered estimates. The Discount stores, Wholesale Clubs and Drug Stores were the only real gainers. Apparel and Footwear lost ground from October. Estimates for December are for a +4% to +4.5% gain and while this is up from November it is still below the late summer months in the 5.5% range. Only a few stores said the post Thanksgiving sales were strong. Wal-Mart specifically did NOT mention post holiday sales and DID say sales in early November were stronger. Read between the lines and you can probably decide that last weekend was a disappointment for them. Complicating the situation was the fact that last November was the weakest month of the year for chain stores with December the second worst. This makes the comparisons much easier for the current period and they were only able to grow +3.6%. Does not look good for the retail sector. The Retail Index was down nearly -6% from the Dec-2nd high to today's lows. They did benefit from the end of day buy programs and bounced nearly +10 points off the 365.46 low. Also, more than half of retailers MISSED their November projections. The retailers said sales were slower due to lower inventory levels, fewer sale items and smaller promotions. Sounds like the retailers saw the decline coming. Leading the decline in the retail sector were WMT, HD, LOW, JCP, FD and ANN. Going against the trend was Target which gained nearly $1 on its results.

National Semi announced earnings this morning and said profit was up tenfold on lower costs and strong sales from North America and the Asia Pacific region. Wall Street was expecting 32 cents and NSM posted 36 cents. NSM said they expected 4Q revenue to rise +3% to +5%. Suddenly traders were shocked back to reality and the stock dropped over -$3 on the news. Great sales, great profit but only +4% growth? Traders dropped it like a hot skillet and despite an end of day rebound it closed under $42 and well under yesterday's nearly $45 high. This put even more focus on Intel and their mid quarter update after the close.

Intel shocked investors after the close and the shock could carry over to Friday's open. They raised their revenue range to $8.5B-$8.7B from $8.1B-$8.7B. ($8.4B avg to $8.6B) This is not what shocked investors because everyone had already expected them to raise the range. Many had hoped they would raise the upper end but Intel is smarter than that. They give the wide range in their first estimate and then adjust it to the center as the quarter progresses. What shocked analysts was the announcement of a $600 million charge for unsold inventory and good will in their wireless communications and flash memory business. They said growth in that business was less than previously expected. The charge will lower their earnings by six cents for the 4Q. Andy Bryant said they were seeing "normal" seasonal growth with good demand for processors. Analysts never want to hear that growth is normal. Intel dropped -$1 in after hours and all the other chip stocks followed suit.

The problem is the perception of the charge. Intel would want you to believe it was "not normal business" and therefore their -6 cent earnings drop would not be a warning but an adjustment. Some analysts differ on that view. Since Intel is a chip company and that is a large portion of their business they feel at least a portion of the charge is "normal course" and represents a warning. Either way Intel still said the microprocessor business was still strong and strong enough to raise estimates slightly. With the NSM slow growth comments and the INTC earnings charge there is a good chance the semi sector will not be a leader to the upside on Friday.

Another tech stock held an analyst update on Thursday but failed to update anything. IBM spent a considerable amount of time bragging on IBM and trying to suggest there was a tech revolution underway but in the end they never gave any revenue or earnings guidance. It was a pep rally for analysts and nothing of substance. This suggests this thought process. If they had any good news they would have wanted to give it. Companies only disguise the bad news. IBM rarely updates guidance in these analyst meetings so we really can't draw too any negative conclusions despite thinking about them. IBM did rise +1.12 after the dog and pony show.

Jet Blue warned after the close saying that the airline industry was faced with a challenging revenue environment. They said capacity additions by the major carriers were producing lower fares and more vacant seats. Western routes were said to be under the greatest strain. Airlines have been under pressure from rising fuel costs and there are starting to be rumors of lower than expected bookings for the coming holiday travel season. This warning came after Raymond James cut Southwest Airlines (LUV) neutral from buy saying that drops in November airfares could continue into December.

The Nortel CEO said that they expected to see some growth in the telecom sector in 2004 but they did not expect it to be strong. He said there was "no spending boom" in the near future. He also said prospects for Nortel's optical division were weak. NT dropped about 20 cents on the news to $4.40. Considering the downplay I thought this was a positive sign that investors had already priced in the bad news.

Despite all the bad news the markets crawled out of the gates and picked up speed around 10:AM. The Dow moved over the critical 9900 level and reached initial resistance from yesterday at 9925 before stalling. For two hours the Dow struggled to cling to 9925 while the Nasdaq was heading lower. The Dow finally collapsed around 1:PM and fell to support at 9875. This was not a big drop but the fall from 9925 represented a lower high and the beginning of a potential roll over. The 9875 level was support Wednesday morning again Wednesday afternoon at the close. It began as support again this morning so the afternoon retest was a critical fourth test of support.

The Nasdaq touched 2000 right on schedule on Wednesday and almost immediately started down as expected. It fell to a low of 1942 on Thursday, -59 points from the Wednesday high. That 1945 level was initial support and provided a resting place for over an hour before the rebound began.

At exactly 3:PM we saw the first of three broad based buy programs hit the market and A/D line gained +1600 issues over the next hour. The rebound caught everyone by surprise and the speed of the program spikes left most speechless and stopped out of their shorts. The Nasdaq rebounded to early morning resistance at 1970, still well off the 2000 highs from Wednesday but +28 points off the lows and back in positive territory. There was speculation it was short covering before the Intel update and the Jobs Report on Friday. I don't buy this based on the three distinct buy programs and the breadth of each. I suspect it was funds putting November month end money to work ahead of any potential Santa Claus rally. There was also a rumor at 2:55 that MSFT was going to announce a huge share buyback and raise their dividend. MSFT stock jumped +2% in the last hour of trading and a new high for the month.

The Dow was the real winner in terms of gains. The rebound off the 9875 support propelled it to a 9934 close and only 8 points below its intraday 19-month high of 9942 from Wednesday. While the Dow failed to touch 10,000 when the Nasdaq hit 2K it was now poised to make another try on Friday. I saw "was" because there are three big hurdles in its path.

The first hurdle was the Intel earnings warning. Even if it was not a warning it was less than exciting for traders who were expecting just a boost in estimates. The S&P futures fell almost immediately to 1065.50, about -4 points off the close. The Nasdaq futures fell -10 points. Those levels have eased some as the dip buyers speculate on the morning Jobs report.

The second hurdle is the Jobs report itself. The whisper number is about +200,000 jobs and the official estimates are for a gain of +140,000. This sets up the market for a potential disappointment much like the Jobless Claims today. Even if we get another gain in jobs of say +50K or so it will still be less than expected and not a vertical ramp into a wonderland of full employment. With the expectations so high we run the risk of any number being sold as already priced into the market. A really good number would be seen as negative because of the Fed meeting on Tuesday. It would be seen as accelerating the Fed's decision to raise rates or at least change their bias to raising rates. This is where a good number can be bad and a bad number can be good. Lately the good news has been sold as readily as the bad news so the bottom line is that flipping a coin for direction would have a better chance of success than guessing this outcome.

The third hurdle is the continuing flood of terror alerts. It seems like every Thr/Fri we get another round of warnings about potential impending attacks. Tonight was no exception. I know that we have had a hundred warnings to every real event but they keep filling the airwaves with them because they are breaking news. Whether they come to pass or not there is always the fear by fund managers that months of gains could be wiped out on any real event only days before 2003 closes. This has got to be weighing on many managers and with the recent market weakness and the weekend approaching there may not be any incentive to be bullish Friday morning.

I told you on Tuesday I expected a continued bounce this week to 9900/2000 and both occurred. I predicted a sell off in the Nasdaq once that 2000 level was touched and it played out as expected. I suggested that we would then see a dip into next week in preparation for any potential Santa Claus rally. The bounce back to 9934 at the close leaves us right on the verge of either a test of 10,000 before the decline begins or looking at an opening drop on the Intel news, or both. We have seen some serious selling in the Russell-2000 yesterday and today. The buy programs at the close erased an eight point drop on the Russell and brought it back to the 545 level but still down for the day. The Russell tends to be a leading indicator for fund movement. When they decide to exit many funds dump the smaller and less liquid small caps first. The -12 point drop from yesterday's highs, (-20 at the lows for today), is a significant drop. However, one funds exit could be another's entrance. We will not know until real support is violated at 520 and that is several days away even in a directional market. This is just something else to keep your eye on. One measure of market internal strength is the new 52-week highs. I mention this often because it shows the breadth of the market leaders. A decline in the new highs means the leaders are losing support. On a day where the Dow closed at a new two-year high you would expect the new individual highs to be strong. Beginning with Monday the new highs across all markets were 1254, 1113, 902 and today only 444. To put that in perspective the Dow failed to break 9900 on Monday or Tuesday but new highs were over 1100 each day. Yesterday and today when the Nasdaq and Dow hit new highs the individual stock highs were dropping drastically. The new highs today were only 1/3 of the new highs on Monday. Does that indicate continued bullish internals to you?

The market direction for Friday will be determined by the Jobs Report, fear of the Fed and whatever damage is remaining from the Intel news tonight. The Nikkei opened down nearly -70 points but recovered to even in the first hour. No obvious indication of Intel concern there. If I were flat tonight I would find it very hard to go long on Friday. With very strong resistance at 10,000 just ahead and known resistance at Nasdaq 2000 I just do not see a compelling reason to buy stocks. Odds are much better we can buy them cheaper next week as warning season accelerates.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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