Option Investor
Market Wrap

Santa Came Early

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      12-11-2003           High     Low     Volume Advance/Decline
DJIA    10008.16 + 86.30 10026.53  9920.97 1.70 bln   2231/ 899
NASDAQ   1942.32 + 37.70  1945.92  1903.93 1.74 bln   2258/ 851
S&P 100   530.16 +  4.83   531.44   525.33   Totals   4489/1750
S&P 500  1071.21 + 12.16  1073.63  1059.05 
W5000   10430.54 +134.80 10448.80 10295.70
RUS 2000  542.92 + 14.43   542.93   528.49 
DJ TRANS 2965.90 + 53.20  2970.09  2910.84   
VIX        16.74 -  1.13    17.95    16.51
VXO (VIX-O)15.86 -  1.47    17.16    15.66
VXN        26.44 -  1.40    28.05    26.34 
Total Volume 3,812M
Total UpVol  3,286M
Total DnVol    472M
52wk Highs  456
52wk Lows    36
TRIN       0.45
NAZTRIN    0.38
PUT/CALL   0.66

Nobody really knows why but Santa came early to the markets and left a load of goodies for all the nice bulls. The Dow opened up and never looked back and there were as many excuses as there were points on the board but the bottom line was a complete lack of sellers.

Dow Chart - Daily

Nasdaq Chart - Daily

This bullish bounce was surprising on the surface because the primary economic report for the day was negative. The Jobless Claims jumped to 378,000 for the week and the first time over 370,000 since mid October. On the surface this would appear negative as the second consecutive weekly gain but analysts were quick to dismiss the number as skewed by the Thanksgiving holiday. They felt many newly unemployed workers may have put off applying for benefits during the holiday week and that pushed the current reporting week higher. For the first time in recent memory the prior week's number at 365,000 was not revised upward. The four week average moved up to 364,750 and continuing claims rose to 3,346,000. The Jobless Claims were ignored despite it being the highest number in six weeks. When the bulls want to buy do not confuse them with the facts.

Helping boost the sentiment was a larger than expected bounce in the Retail Sales for November by +0.9%. The consensus had been for only a +0.6% gain. While this is still well off the highs from the summer there were worries that it could have been worse. Auto related sales boosted the headline number which would have been only +0.4% without autos. Helping build investor confidence was the +7% increase in year over year sales and suggests that this holiday season will be the best since 1999. This is contrary to the recent dire predictions of retail weakness. This turnaround in retail sentiment helped inspire traders and put the spirit of Christmas into their holiday stock shopping.

The Business Inventory number rose by +0.4% for October and was twice the consensus estimates. This was the second month of gains for inventories and sales rose at an even faster rate at +0.7%. This pushed the inventory to sales ratio to 1.35 and an all time low. This suggests that the 4Q GDP could already be building to stronger than expected levels.

The last economic report was the Import and Export Prices which rose unexpectedly by +0.4%. While the FOMC minutes discussed below claim there is no danger of inflation there are several signs of the inflation monster creeping back into the picture. Import and Export Prices is one of them. A +1.1% increase in petroleum prices helped fuel the headline number but ex-energy the prices still rose +0.3% overall.

The biggest impact to the market came from the FOMC minutes for October that were released at 2:PM. The outlook expressed in the minutes was for continued growth and shock that the growth was so strong in the 3Q. However, there were some surprises. Some of the members expressed willingness to change the bias if the economy continued to strengthen in the 4Q. We saw that morphing of the bias in the Dec-9th announcement when they tied inflation to that considerable period statement.

Other surprising views included a doubt that employment will rise substantially until LATE 2005. This is a huge change in expectations. Last month we had every Fed head on the panel making speeches about growing employment and how jobs will follow the recovery. Nobody said they would follow two years later. The other statement causing excitement was a very distant view of any inflation problem. They felt the economy was growing too slow to produce any inflationary conditions for quite some time. This was interpreted by many as late 2004 or even early 2005. This was a huge positive for the market. With the bond market keying on jobs as the primary reason for the Fed to not raise rates and inflation not expected to be a problem for a long time the obvious conclusion was the Fed is not going to raise rates for an even longer period than originally thought. I had mentioned earlier that due to the election any hike had to be in March or before and after today's Fed minutes release it is extremely unlikely that hike will happen. The conventional wisdom tonight is no rate hikes until 2005. We speculated about this last week and now it almost appears to be a sure thing. If there was any bad news it was the traders pricing this into the market and setting themselves up for a monster disappointment if conditions suddenly change in March.

Overall the Fed was very optimistic about the economic outlook but almost unbelievably calm about the potential for inflation. If you believe them inflation is on hold until after the election. Quite a coincidence. They feel business spending is filling the gap the consumer created in the 4Q and will continue to grow. The biggest shocker was their outlook was so far reaching going to late 2005 in some areas and they were not seeing any need to make changes for quite some time. This is a major relief to the bond market and to the equity market. Thank you Santa.

Tech stocks got a boost from Cisco after CEO Chambers said they were seeing a rise in orders and a rise in budgeting for 2004. PC box makers also got a boost from an IDC survey that said PC shipments for 2003 are going to be +9% higher than 2000, which was a record year and +11.4% over last year. Notebook computers are the hot item with desktops lagging. Dell said customer traffic for the first week of December totaled nearly five million visitors compared to only four million in the same week last year. HPQ CEO Carly Fiorina also said this week that holiday sales were going well.

I have mentioned this several times in the past but I think it bears repeating. I think the PC makers are all beating each other up on price point and nobody is really making any real money. We bought two 2.0GHZ computers over the last couple weeks to replace some Y2K 600mhz models. We paid $289 plus shipping for 2.0GHZ Intel, 256MB ram, 40GB disk and all the bells and whistles. (no monitor) Considering the computers I replaced cost me over $2000 each three years ago where is the profit? Using the ratios above the box makers have to sell seven boxes today to equal the gross revenue of only one box three years ago. Like the HWP CEO said last week, Dell is trapped in an ever increasing price/commodity struggle with no way out. While that is obviously a biased view it does have a lot of truth. This is why Dell and others are rapidly trying to branch out into consumer electronics, cameras, printers, plasma TVs, etc. Computers have no profit left and they have to sell 25% more each quarter just to break even. If it were not for the boom in notebooks the PC makers would be in serious trouble.

Despite the problem mentioned above the tech stocks took off on the double dose of good news about rising IT budgets and higher PC shipments. The SOX bounced +2.54% on the news that Taiwan Semiconductor said 4Q sales would beat forecasts and hit a record high. This was an unusual move and came on the heals of cautious comments on Tuesday by TSM and United Microelectronics that November sales would be flat or down from October. The semiconductor sector had dropped strongly on the earlier news and TSM sought to correct the impression that business was bad. I guess it is all in how you report the numbers. November could be flat to down but maybe it was flat to down from a strong October. Maybe December orders surged strongly. It just seems strange to caution on Tuesday and then guide higher on Thursday.

The markets blasted out of the gate this morning and the Dow came very close to 10,000 at 9993 but was unable to break that psychological level. The Dow traded sideways with a very slight negative trend until the ten-year note auction concluded badly and it dropped to near 9960. When the Fed minutes were released and investors got a glimpse of a distant future without rate hikes and no inflation it was too much for those undecided investors to take. The Dow surged to break 10K and traded over that level into the close. While the close over 10K was the first close over that level since May-24th 2002 it was barely convincing. The 10026 high lasted for about 20 min before the profit taking began. Even then it was very light profit taking and they managed to hold the 10K level. The Nasdaq tacked on +37 points but was unable to touch the 1950 resistance level.

In reality neither the drop yesterday or the bounce today is relative to anything but the reporters. According to sources that claim to know there was a large mutual fund unloading some major positions on Tue/Wed after the first touch of 10,000. They concluded their selling yesterday afternoon and the rebound began. This makes sense to what we saw intraday today. The market did not move up prior to the FOMC minutes in normal fashion. The gains were slow and methodical with no bouts of selling. There were only a couple of noticeable buy programs and no sell programs. In fact there was almost no selling at all.

The market internals were very lopsided with only one missing ingredient. The advancing volume was 6:1 over declining volume. Very bullish under any conditions. The declining volume across ALL markets was only 472 million shares with 3.3 billion in advancing volume. What was missing was volume. With only 3.7 billion shares overall that is less than the 4.1 billion on the down day on Wednesday. Those volume levels are well below the 4.5 billion share days we were seeing when the market was rising in October. Also light were the new 52-week highs. Despite a 5:2 advancer over decliner ratio the new highs across all markets were only 468. This is well below the 1100-1200 levels back on Dec 1st/2nd.

The most bullish factor I saw was the +14 point jump in the Russell-2000. This was very strong and indicates a new round of buying by funds. At this stage in December this is very bullish. The RUT retraced nearly all the selling for week in only one day.

Where are we going from here? This is the $64 question tonight. The Dow closed right on psychological resistance at 10000 and the Nasdaq is stuck under 1950 resistance. The Wilshire 5000 did NOT set a new high and only managed to retrace to 10450 resistance. The high was 10506 last week. The S&P also failed to reach a new high. With the Dow standing out in the crowd I glanced at the Dow stocks for a hint of what happened. CAT soared +1.94 on news that their Chairman and CEO would retire and be replaced by a 30 year veteran. Home Depot rose +1.45 on news of a new $1 billion share buyback and news that they had $5 bil in cash at the end of the 3Q despite completing a $3 bil buyback since July-2002. UTX jumped +1.00 on new guidance to +14% earnings growth. AA jumped +.92 on news that China wanted to import more raw aluminum and that a supply shortfall in China was causing a spike in the price. Finally MO rose +.78 on a favorable court ruling and BA spiked on a contract win. Those six Dow stocks accounted for +56 points of the +86 points the Dow gained. Not exactly a strong showing.

This produces some conflicting indications. Breadth was strong but new highs were weak. The Dow broke to a new high that just happened to be over 10,000 but all the other indexes failed to follow suit. On the surface it would appear that a Santa rally had begun. Considering that sentiment is a surface commodity anyway the positive press tonight could help stimulate buyer interest on Friday. The Nikkei opened up +140 points and our futures are positive in the overnight session. All seems well with the market.

I suggested on Tuesday that the Dow would probably test strong support at 9850 before beginning the Santa rebound. On Wednesday the low was 9882. Evidently there were enough traders watching the 9850 support level that they jumped in front of that level and the race was on. It helped to have that mutual fund run out of stock there as well. I have to admit I am surprised. I did not think the Dow would close over 10K until next week or even Christmas week. Now that we are there the markets may lack motivation for any future gains. The distinct lack of any short covering makes me wonder if anyone believes there could be a higher high in our future. Now that we have closed over 10K there is congestion all the way to 10,300. It will not be a walk in the park to higher ground. My view for the rest of the year was to remain range bound between 9700-10000. The minor move over 10K has not changed my view but I may need to raise the upper boundary depending on Friday's action. Economic reports for Friday include the PPI, International Trade and Consumer Sentiment. None should be market movers unless there is a significant change in the readings. If you are not in the markets tonight I would probably not go long at the open. You may want to err on the side of caution and wait until Monday to see if the apparent bullishness holds until next week. We saw what profit taking from one fund can do and as long as we hold at the 10K level without moving higher we have a bulls eye on our back and carrying a sign saying bears are sissies. It is dangerous to tempt fate this close to year end.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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