Option Investor
Market Wrap

Confusion Reigns

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      01-15-2004           High     Low     Volume Advance/Decline
DJIA    10553.85 + 15.50 10592.74 10477.18 2.21 bln   1597/1650
NASDAQ   2109.08 -  2.10  2121.61  2088.10 2.22 bln   1646/1516
S&P 100   560.42 +  0.65   562.96   556.96   Totals   3243/3166
S&P 500  1132.05 +  1.53  1137.11  1124.50 
W5000   11036.78 + 13.80 11080.04 10959.60
RUS 2000  586.36 +  0.24   587.31   579.30 
DJ TRANS 3018.48 - 13.10  3032.01  3001.04   
VIX        15.56 -  1.19    17.31    15.49
VXO (VIX-O)16.23 -  0.47    17.31    16.04
VXN        22.64 -  0.53    24.03    22.18 
Total Volume 4,827M
Total UpVol  2,413M
Total DnVol  2,200M
52wk Highs  921
52wk Lows    12
TRIN       1.00
NAZTRIN    0.88
PUT/CALL   0.58

Good news, Bad news and news overload all combined to confuse investors on Thursday. The earnings parade began with some tech leaders and while the earnings were good the guidance was questionable to some. Techs crashed, soared and crashed again as volatility returned to the stock market. Expectations for more tech earnings after the close today kept a floor under the afternoon selling. After yesterday's news you would have expected the opposite. Earnings runs appear to be alive and well.

Dow Chart - Daily

Nasdaq Chart - Daily

The markets are in "hold your breath" mode as we await the various earnings announcements. With each release there is the normal rapid fire trading as winners and losers quickly exchange shares while the talking heads on TV weigh the opposing benefits of each line item on the announcement. The magnitude of the tech announcements over the last two days has left tech investors in a daze. There were four big techs last night, IBM this morning and four more techs tonight. The consensus of opinion on tech earnings appears to be the 4Q was a decent quarter with strong buying in December. The general guidance is positive with comments like "starting to see a pickup in IT spending" and several firms have raised their outlook. If everything is so positive then why did the markets end flat today?

First we need to review the economics for the day. You could not have asked for better results in most cases but there are still some questionable signs about the recovery that worry analysts. Jobless Claims continued to fall at 343,000 and a drop of -11K for the week. The four-week moving average fell to 348,000 and the first time under 350K since early 2001. Continuing claims also fell to 3.13 million and that suggests we may be seeing some hiring. If historical trends continue we should see a pickup in Nonfarm Payrolls soon. In 1992 during the last post war recovery we saw a sharp pickup in new jobs once claims fell under 350K a week. Still far too soon to draw conclusions but we are on the right track.

The Consumer Price Index only rose +0.2% in December and the Core rate rose only +0.1%. This makes the core inflation rate for all of 2003 only +1.1% and a 40-year low. The index should slow again for January after the impact of mad cow on our beef prices. The headline inflation rate of +1.9% is a 16-year low. The Fed is on track with the claim of no inflation in sight despite the rapid acceleration in commodity prices. However, inflation tends to appear suddenly and you can bet it will not stay at multi-decade lows for long if this recovery really catches fire. But, that is a problem for the post election Fed.

The NY Empire Manufacturing Survey soared to 39.2 and a record high. This was well above the consensus estimate of 34.5. The manufacturing industry in New York suddenly seems to be exploding with 86% of survey respondents reporting new orders last month. Shipments have increased for five consecutive months. Prices paid jumped to 28.2 from 12.5 but prices received only rose to 3.9 from -1.0. Seeing a trend here? You can sell anything if you give it away. With costs rising but prices remaining low it will put a squeeze on profits if it continues. The employment component fell slightly but the average workweek jumped to 19.0 from 6.6. This suggests the need to add employees in the future now that hours are rising.

The Philly Fed Survey echoed the results in the NY Survey. The headline number jumped to 38.8 from 30.2 when the consensus was looking for a slight decline to 29.0. This was the highest reading since 1993. Contrary to the NY Survey there were some larger signs of inconsistency. Employment fell along with the average workweek. The six-month outlook also fell. Unfilled orders fell to 10.7 from 15.5. New Orders dropped slightly and shipments fell to 33.1 from 39.6. The only component that rose materially was prices paid which again suggests a profit squeeze. The bottom line was an increasing manufacturing environment but increasing at a slower rate. The weak components could have been due to a seasonal influence but we have to wait until February to find out.

The MAPI index of future business activity rose to 77 for December and suggests that manufacturing activity is about to surge. This was the highest number on record for the entire 31 years of the index. Typically the MAPI index predicts business conditions 3-6 months in the future. The MAPI index is a quarterly index and the prior number for the quarter ending in September was 68. The advance shipments component jumped to 91 for December. This projects shipments for the 1Q of 2004. Backlogs rose to 67% from 51% in Sept. Unlike the NY and Philly surveys the MAPI survey is a forecast based on the last quarter where the others are current conditions surveys.

The monthly retail sales for December came in at +0.5% and below consensus of +0.8%. If you take out autos the increase was only +0.1%. This was not an exciting December but we already knew that from the weekly numbers. Were it not for the reported surge in the week before Christmas it would have easily been negative. While on the surface it looks bad it is deceiving. The headline number compares sales to the prior month. If you compare it to the prior December you get a healthy +6.7% growth. It is all in how you report it. It was the best fourth quarter for non-auto sales since 1999. Surprised? Oct/Nov were still seeing the cash from tax rebates and mortgage refinancing. Had it not been for December dragging down the numbers the quarter would have been much higher. This will create some seriously tough numbers for comparisons in 2004 for both the 3Q and 4Q.

Economic reports due out Friday include Business Inventories, Industrial Production and Consumer Sentiment.

What a day for stock news! I am not going to rehash the earnings from last night except to show how investors voted their approval. INTC -0.33, YHOO -0.30 and a big recovery from a -2.50 intraday loss. QLGC -2.68 and AAPL -1.35. The losses would have been a lot bigger had it not been for IBM and their strong earnings and guidance. This reversed the tech sector depression helped lead the markets back from the depths.

IBM posted surprisingly strong results and by changing their release date after the close on Wednesday caught everybody off guard. Services contracts, which had been rumored to be a weak point in December, soared and beat estimates by a wide margin. The backlog of service orders rose to a monster $120 billion. IBM earned $1.56 per share with estimates only $1.50. Only $1.50? Obviously any company would be thrilled to earn $2.7 billion. For the first time in years IBM gave a long term outlook and suggested analysts were light on estimates. That put the squeeze on those suggesting that IBM was mired in problems and on those short the stock.

The only real problem for those results was the currency translation issue. IBM reported a +9% jump in revenue to $25.9 billion. If you remove the currency impact that number drops to only a +1% gain at $23.9 billion. That is nearly a $2 billion windfall because of the low dollar. Obviously investors did not care that the headline numbers were so grossly misstated because IBM rose +3.71 to 94.05. Revenues from global services, 44% of IBM total revenue, increased +8% to $11.4 billion. However, the revenue gain for services was ENTIRELY due to currency translation. Software revenues grew +12% on the surface but only +2% without the currency benefit. Despite the strong earnings and strong gain in stock price I would not be surprised to see some weakness ahead as the numbers are reviewed. The gains on Thursday were obviously on strong short covering due to the headline number. Traders did not suddenly decide to buy 20 million shares just because they beat estimates by six cents on currency translation. I read the earnings report forward and backward and I cannot find ANY statement of how much of the EPS was due to currency translation. I guess they would rather we not know. Keep an eye on IBM over the next couple weeks.

After the bell today we saw earnings from JNPR, SUNW, CREE, RMBS and TMTA. All met or beat estimates. CREE beat estimates by +2 cents and raised guidance. The chip sector had started the day out in the hole after Intel and a sector downgrade by SG Cowen. Smith Barney removed Intel from their focus list and added to the opening depression. CREE helped to change that sentiment with their guidance. CREE upped guidance for the current quarter to 17-19 cents per share when analysts were only expecting 15 cents.

RMBS beat the street by three cents and said revenue for the current quarter would be slightly higher. TMTA posted a loss of -13 cents after items and inline with estimates. They guided analysts to a loss of 11-12 cents for the current quarter.

The big guns were SUNW and JNPR. SUNW posted a smaller than expected loss but they refused to give any guidance. They said that business was pretty much on track and they had seen some upside surprise in the 4Q. CFO McGowan said the +14% sequential growth was the best quarter since 1998. The markets did not react strongly to Sun's earnings due to the lack of guidance. Scott McNealy did take a shot at IBM and their optimistic outlook. He said IBM must have a lot of economists on staff whose salaries are getting bundled into the price of IBM products. He said he couldn't see the future and unlike IBM he cannot predict future economic recovery.

JNPR was the star of the after hours earnings show. They beat estimates by +2 cents and said they expect to easily beat analyst estimates for the 1Q. Whoa! JNPR said they expect to make +8 cents for the 1Q and that is +3 cents over current estimates. The conference call was positive and very upbeat. It is 1999 all over again except that customers are buying only what they need when they need it and that is keeping the sales healthy on an ongoing basis. JNPR has recently signed some big contracts and has partnered with Lucent to produce products helping them both. Business is good but they are trying not to get too excited just in case it changes. JNPR was the leading reason for an upsurge in futures after the close and they were still moving up at 8:PM.

Intel said they were seeing an uptick in enterprise purchases and IT budgets were increasing. IBM suggested they were finally seeing the first signs of a real IT recovery. They had said last quarter that they were not. CREE upgraded guidance and JNPR hinted that they might double the estimates. Sure looks like the bulls are back.

Happy days are here again seems to be the common thread from tech earnings, manufacturing surveys and inflation gauges. The Fed is on hold for the rest of 2004 or so the current conventional wisdom says. Bonds are moving up again and yields on the ten year note closed at 3.97% and a 3-month low. What is wrong with this picture?

Even with all the good news the Dow gained barely +15 points and the Nasdaq finished in the red. That is actually good news considering the gap and crap at the open. The less than expected guidance from last nights earnings prompted a sell the news event that knocked the Dow back below 10500 and the Nasdaq back to 2088 before the buying began. The morning drop was swift and the afternoon rebound was strong but slower.

Unfortunately the internals do not show the same strength. Volume was equally split between advancing and declining and it was heavy. Advancing and declining issues were even. The Dow, Nasdaq, Russell and Wilshire all set new 52-week highs by a handful of points but pulled back again at the close. The pullback was no surprise with more tech earnings on tap. After the morning drop I was surprised the pullback was not stronger on fear of those earnings.

We are poised to breakout of the recent resistance highs. It is the third week of January and we have traded generally within 100 points of 10500 for the entire month. There has been no historical January dip and time is running out. Friday is option expiration and Monday is an exchange holiday. Next week is a massive deluge of earnings but we already know what they are going to say. All the factors are in place for a strong surge or a strong drop. Neither direction is a sure thing.

The churning at the resistance highs is a potential sign of distribution. It represents indecision and proven by the return of volatility. This is good because it means the entire investing public is no longer bullish. There is a growing undercurrent of confusion. If you bought stocks over the last three months expecting strong earnings in January then you got your wish. Now what? So far the guidance has been for continued growth and those that were planning on selling the bounce are now thinking about holding until April. Those that were on the sidelines hoping for a nice dip to buy are trapped. Chase the new highs or continue sitting out? Tough question. I know the minute I go long the top will be in place. If I remain short we will go higher. Millions of others are thinking the same thing tonight. This is creating a very shallow bottom. You saw the drop on Tuesday to under Dow 10400. It was bought with reckless abandon once traders were sure it was not going deeper. Buyers are waiting.

The only plateau we have not crossed to the upside is the Dow highs from 2002. The actual intraday high was 10673 but there was nearly a month of range bound trading between 10500 and 10650. Dow 10600-10650 is generally considered the critical resistance range from that period. Ironically we have traded for all of January in the same general range between 10500 and 10600 with only a couple minor dips to the downside. We have not yet tested 10600 completely with all four attempts to move over 10580 turned back. This means the jury is still out on any move higher. Until that 10600-10650 level is behind us we are still trapped in a range. The January expiration cycle could have had something to do with the gains since Tuesday's lows. In December we saw the same thing. The markets had gone higher than expected and option sellers were trapped with shorts that had to be covered. Countless traders probably rolled those positions forward thinking they could escape the trap for sure during the January dip. With no dip in January the trap is squeezing ever tighter.

With Friday an expiration day and Monday a holiday there is no way to predict market direction. I am watching futures rise as I type this and it looks like we are going to gap open again tomorrow assuming GE earnings before the bell are not unbelievably bad. Since they almost never miss or warn I can't imagine that will happen. The three economic reports are probably not serious market movers considering the good news we have already seen this week. That leaves us watching for expiration gyrations with some possible profit taking before the close. On expiration Friday in December we had a gap open, intraday slump and a strong rally into the close. January expiration is a tossup and a day best watched from the sidelines. Entering new plays could be very risky. There is also the risk of being long over a three day weekend. Sounds like a good day to plan your trades for next week instead.

Enter Passively, Exit Aggressively.

Jim Brown


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