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Market Wrap

Volatility Returns

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      01-27-2004           High     Low     Volume Advance/Decline
DJIA    10609.92 - 92.60 10701.77 10609.92 2.10 bln   1405/1835
NASDAQ   2116.04 - 37.80  2152.75  2116.04 2.14 bln   1336/1936
S&P 100   567.15 -  6.29   573.44   567.15   Totals   2741/3771
S&P 500  1144.05 - 11.32  1155.37  1144.05 
W5000   11177.42 -104.40 11281.80 11177.42
RUS 2000  595.17 -  6.33   601.50   594.93 
DJ TRANS 3041.22 - 25.50  3074.18  3033.34   
VIX        15.35 +  0.80    15.44    14.74
VXO (VIX-O)15.32 +  1.00    15.41    14.75
VXN        23.03 +  2.04    23.07    21.60 
Total Volume 4,634M
Total UpVol  1,533M
Total DnVol  3,054M
Total Adv  3139
Total Dcl  4258
52wk Highs  905
52wk Lows     6
TRIN       1.19
NAZTRIN    2.02
PUT/CALL   0.87

After a +134 point gain on Monday to a new two year high the Dow slipped -92 today as put buyers outweighed call buyers almost 3:1. The Nasdaq gave back all its gains from Monday and returned to the low 2100s on weakness in the semiconductor sector. Volatility may have been higher today but it is still at relatively low levels. Considering our markets are at two year highs this is not surprising. When the bulls are running the volatility gets trampled.

Dow Chart - 120 min

Nasdaq Chart - Daily

The economic calendar was slim today with only two reports. The Chain Store Sales showed a jump of +1.1% for the week after three weeks of decline. The Southwest was the strongest region as blizzard conditions and severe cold hampered those consumers in the Northeast. The ICSC raised it estimates for all of January to a gain of +4.0% to +4.5%. This is a +1% gain over the prior +3.0% to +3.5% estimates.

The Consumer Confidence hit an 18 month high at 96.8 but was less than consensus expectations at 98.5. The December decline was reversed on the strength of a gain in the present conditions component. Not all components were rosy. Plans for new purchases slipped slightly and availability of jobs only increased slightly. The lower than expected headline number may have been influenced by the blizzards across the country. Fighting the elements tends to depress consumers and makes them less receptive to shopping. We all know shopping is a mood elevator for at least half the population. Confidence should continue to rise as long as employment continue to improve. Once the tax refunds start flowing the urge to spend will also grow.

Kraft (NYSE:KFT) did not help confidence when they announced they were cutting -6,000 jobs including 1,300 salaried jobs over the next three years. They will take a charge that will impact their earnings for these layoffs.

The news was all about Martha Stewart and earnings today. Since we are all Martha'ed out I will not bore you with what she had for lunch or how many powder room breaks she had. We will concentrate instead on the real news with several Dow stocks announcing earnings.

Merck (NYSE:MRK) announced a fourth quarter profit that fell -26% due to a decline in sales and charges for recent job cuts. MRK posted +62 cents per share and reaffirmed its 2004 full year estimates. MRK traded up fractionally for the day and up +1.50 for the week to $47.35. It looks like new life is coming back into the stock after being a Dow dog for the last six months. Drug stocks are normally defensive and MRK could be benefiting from the rotation out of chips.

Another Dow component, DuPont, lost -50 cents despite beating the street and issuing an upbeat outlook for the year. SBC lost -74 cents to close at $26 after posting a drop in profits and rising employee costs. The results were inline with estimates and were uninspiring. Investors are watching the decline in the telecom sector as each of the major players reports. Wire lines are dropping and with them the monthly and long distance revenues.

McDonalds gained +17 cents inline with expectations on an increase in sales due to a restructured menu. Salads and chicken are beating out hamburgers as the high profit items.

The biggest loser on the Dow was Caterpillar despite a surge in revenue to $6.47B from $5.38B and beating estimates by +3 cents. The drop in stock price was due to the retirement of their CEO and new guidance. The company said they did expect 2004 earnings to jump +40% and revenue +12%. They did not give short term guidance as they had in the past and simply said 2004 will be strong. This prompted some analysts to suggest they were hiding a weak first half. Also, much of their gains were due to currency translation benefits from the weak dollar.

Other major earnings of note with misses or lowered guidance included BK, LMT, CNF, RTN and DJ. After the bell we saw another flurry of tech earnings and most were positive.

AMZN est +0.29, act = +0.29 inline, raised guidance
BRCM est +0.16, act = +0.19 beat
FLEX est +0.14, act = +0.17 beat, raised guidance +3 cents
AFCI est +0.09, act = +0.10 beat
ADVP est +0.55, act = +0.55 inline
EFII est +0.21, act = +0.27 beat
CYMI est +0.00, act = +0.04 beat
ERTS est +1.20, act = +1.26 beat
MENT est +0.31, act = +0.30 miss
MLNM est -0.31, act = -0.30 beat
MGAM est +0.48, act = +0.48 inline
PXLW est +0.09, act = +0.06 miss
NTIQ est -0.01, act = -0.04 miss
HRS est +0.49, act = +0.50 beat
ELX est +0.23, act = +0.24 Raised guidance +2 cents
RHI est +0.03, act +0.03 inline
NET est +0.21, act +0.26 beat
AV est +0.05, act +0.07 beat

The two biggest newsmakers were AMZN and BRCM. Amazon did report blowout 4Q revenue and its first ever back to back quarterly profit. Proforma earnings were 29 cents and that was inline with the consensus estimates. They raised the Q1 revenue estimates to $1.39B to $1.49B and well above prior estimates at $1.32B. Unfortunately they did not provide profit estimates. Analysts are expecting +16 cents for Q1 and with higher sales you would think they would be inline or maybe even beat. Analysts were worried that margins may not be as good in the 1Q due to product mix. Also the company benefited greatly from currency translation issues in the 4Q. $98 million in revenue and $6 million in profit came from currency gains. With the decline in margins and higher shipping costs there were plenty of questions for AMZN. They also said there was a disturbing rise in inventory levels which could be pointing to a slow down in sales. AMZN traded down -$3 in after hours.

BRCM beat the street by +4 cents but the stock dropped sharply on news they were going to issue $750 million in new stock or debt. That was quickly reversed when they raised guidance on the conference call and suggested sales could grow as much as +10% in the 1Q. The +10% number works out to $527 million and well above the prior estimate of $463 million. The company said they saw substantial new bookings late in the 4Q and early in the 1Q and that new enterprise spending could provide a big opportunity. They are planning on issuing 30 million new shares to enable a future acquisition. Four companies bought more than 48% of Broadcom's output. Dell, Cisco, HPQ and Motorola each bought more than 10% with HPQ the most at 15%.

MSFT dropped -55 cents on news that the EU may issue a negative ruling against Microsoft and try to substantially change the way Microsoft does business. This is old news but the European Commission did confirm it was wrapping up its investigation. The EC has a draft decision and those are normally used to exercise leverage against the company in advance of the final ruling. Microsoft said it was in active talks to insure a positive resolution. Sounds like they are in a tight spot and the EU/EC is applying the screws. The EU has threatened to force Microsoft to strip Media Player out of Windows to give RealNetwork and Apple a more competitive opportunity.

Overall earnings have been very strong. The best in ten years according to some analysts. First Call said earnings were coming in at +25% so far and could rise to as much as +27% as some smaller companies announce next week. This is a very strong quarter and helped by a weak comparison to Q4-2002. The average company beating estimates is beating by +19% compared to an average of +6% in normal quarters. The only problem is in the guidance. Because the good results have been expected for two months many stocks are seeing their prices battered when they announce. When expectations are so high it takes almost super human guidance to attract new buyers after the announcement. Guidance has been good with quite a few companies raising their outlook but it has not been exceptional.

SOX Chart - Daily

Some of the stocks getting hit the worst on good news have been the semiconductor stocks. The sector is well off its highs with the SOX dropping -7% in just the last five days. This includes the monster gains from Monday's romp that were completely erased on Tuesday. At 517 the SOX is very close to ending the month with a loss. The high of 560 was set back on the 12th. NVLS posted earnings on Monday night and dropped -5.85 on Tuesday. KLAC lost -1.70, PHTN -3.66, MXIM -3.05, CCMP and UTEK about -$3 each. SNDK continues to sink lower with another -2.20 today. If the SOX is the leading indicator for the Nasdaq then it is no surprise that the Nasdaq gave back all its gains from Monday and is down for the week with a -37 point drop today. There was a rumor making the rounds today that PMCS was seeing an order slowdown from Cisco, which is its biggest customer.

Are we doomed to drop from here? Not necessarily. Remember earnings are excellent. It is just that investor profits are in the excellent category as well. Remember also that we have a Fed meeting underway that will end at 2:15 Wednesday afternoon. There is high risk that the Fed will change its bias statement and traders are just taking some profits off the table in advance. I am just surprised it did not happen on Monday. The afternoon buy program that triggered the short squeeze was entirely out of character. The bounce that ensued simply gave investors one more chance to exit at two year highs and dodge a fickle Fed statement.

Tomorrow afternoon we will either get the "considerable period" statement or we won't. With the market at two year highs and earnings the best in ten years my bet is we get a new bias. If they are ever going to get a free shot this is it. The bullish sentiment is still so strong it is nearly bulletproof. According to Fed watchers there is almost no chance of a rate hike so they are playing the rate lottery with OTM options. As long as there is a "considerable period" statement they are looking at six months before the Fed will hike rates. Should that statement disappear and language about strong economy and rising employment appear in its place then bonds will die. By changing the statement they are loading the rate hike gun. It does not mean they are cocking it but just the presence of a loaded gun is enough to strike fear in the bond markets and by association the equity markets. Nobody expects any hikes this year so this is all just positioning and speculation but the best of all worlds is already priced into the market. Any change in the bias could cause temporary movement. That movement could be a couple hours or a couple days but is not likely to be lasting. Bond yields have already spiked up over the last three days on fear in advance of the meeting.

Any market shakeup should be brief based on the current bullish sentiment. That sentiment could change at any time but it won't be because the Fed says the economy is strong. If it changes it will simply be due to the overbought conditions and lack of a catalyst to move higher. Let's face it, Monday's move was very bullish. The Dow moved over two year resistance highs to close at 10700. This clears the way to 11,000-11,300 for the next serious resistance. The Tuesday drop held over 10600 and still in bullish territory. The flaw in Monday's rally was the Nasdaq which stopped at 2150 resistance once again and the Russell which stopped at 600 resistance. These are strong levels for both indexes considering their overbought conditions.

The market drop on Tuesday was literally led by the SOX. This sunk the Nasdaq and dragged IBM and INTC and the Dow down with it. CAT did not help either. However, help is on the way. The SOX got help from the BRCM earnings tonight and the 517 close is only +2 points above support at the 50 dma. This is the key point to watch in the morning. As long as the 50dma at 515 holds the Nasdaq is not going very much lower. The Nasdaq has strong support itself in the 2085 to 2110 range. We do not need to start worrying until the Nasdaq trades below 2085.

The Dow has strong support at 10600, 10500, 10400 and 10300. We would have to see a serious trend change to break all those levels. The biggest potholes in our future are the Fed announcement at 2:15 and the GDP on Friday. The economic calendar heats up beginning on Thursday and continues into next week. Recently economics have been market favorable and until that changes traders need not fear the normal reporting cycle. The GDP has the biggest potential. A number under +4.5% would be a shocker especially after the strong earnings. Analysts are now expecting another blowout and that expectation could be the biggest hurdle. The Fed will have advance notice of the GDP in their meeting and will have already acted accordingly.

Expect some volatility to appear when the Fed announcement is made at 2:15 and then a choppy market the rest of the day regardless of the announcement. Sanity should return by Thursday but that does not mean the markets will be directional. Friday is month end and window dressing should keep us in the current range if there are no economic disasters. For the rest of the week keep your eyes on the SOX and 515. As long as we do not stray too far away from that level we are still in striking distance of a new high. Should it break that level on good news then profit taking could take it down to 475 with a pause at 500. Use it as your market guide and you will not be far wrong.

Enter Passively, Exit Aggressively.

Jim Brown


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