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Market Wrap

Buy The Dip?

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      01-29-2004           High     Low     Volume Advance/Decline
DJIA    10510.29 + 41.90 10522.59 10417.85 2.43 bln   1171/2078
NASDAQ   2068.23 -  9.10  2087.33  2041.07 2.64 bln   1059/2131
S&P 100   563.10 +  3.61   563.33   557.36   Totals   2230/4209
S&P 500  1134.11 +  5.63  1134.39  1122.38 
W5000   11045.72 + 28.80 11058.26 10932.72
RUS 2000  579.86 -  4.05   586.81   573.34 
DJ TRANS 2971.99 +  4.30  2986.68  2948.35   
VIX        17.14 +  0.36    17.66    16.79
VXO (VIX-O)17.11 +  0.01    18.01    16.93
VXN        25.20 +  0.04    26.24    25.05 
Total Volume 5,521M
Total UpVol  2,022M
Total DnVol  3,415M
Total Adv  2523
Total Dcl  4784
52wk Highs  271
52wk Lows    16
TRIN       0.85
NAZTRIN    0.90
PUT/CALL   0.80

Some traders bought the dip as the indexes neared critical support but there was no V bottom blast off as many had hoped. The low of the day came around 2:PM with alternating buy/sell programs fighting for control. Is this the bottom or better yet, is this the correction we needed?

Dow Chart - Daily

Nasdaq Chart - Daily

The morning started off with another drop of -1,000 in the Jobless Claims but with the prior weeks number revised up +2,000 the net result was a rise. Regardless of how you add it up it was just one more week without any jump in the numbers. This was the third week in the 343,000 range and the four week moving average came in at 346,000. The total insured unemployment rate is down to 2.5% from the peak at 3.0% in late May. We are going in the right direction but we are not going very fast. Forty-seven states saw a drop in claims for last week. Florida had the largest gain in claims due to numerous layoffs.

The Employment Cost Index jumped +0.7% for the 4Q but it was less than analysts had expected at +0.9%. Wages dropped but health care benefit costs rose. The drop in wages and the outsourcing of jobs is helping companies tack on additional earnings but slowly depressing real income. It is a good thing inflation is very low or the middle to lower income workers would really be suffering. Wages grew by only +2.9% for the year while employment costs rose +3.8%. Benefit costs rose +1.2% in the 4Q and +6.3% for the year.

The Chicago Fed National Activity Index came in at only +0.13 for December and well below the +0.68 for November. That November number was revised upward from +0.55 and indicated a stronger bounce in the middle of the quarter and a fall off in December. Output components only added +0.05 to the index and well off the +0.54 contribution in November. Employment fell for the 11th straight month. Only 44 of the 85 components were positive for the period. One analyst said the headline number of +0.13 clearly showed that the economic recovery was gaining strength thanks to strong productivity growth. Sorry, I see a significant drop from November and a barely breakeven ratio on the components. It was the fourth consecutive positive month although it was only barely positive. Let's count our blessings and not worry over what could be in the future.

The Help Wanted Index dropped one point to 38 but should not be considered a negative event. It has been holding the 37-38 range since June. The negative connotation would be due to the lack of a gain. If advertising for employees is not picking up then the Jobs report next Friday could also be flat. Analysts would love to have seen even a small jump over 40 to suggest a pickup in employment activity but they will have to wait for at least another month. If the economy is improving you would think employment advertising should be showing at least a minor increase. This always causes analysts to suspect the economic growth is not as robust as they hoped. Next Friday we get the answer. There is always the chance that consulting firms, internet job firms, search networks and the flood of unsolicited resumes are taking away the need for those advertisements.

To confirm that thought process the Labor Turnover Survey also out today showed that layoffs are down -14% from year ago levels. Job openings have increased by +1.8% and new hires are up +3.1%. This was only the second month since the survey began in 2000 that there was a year over year increase in job openings. According to the JOLTS numbers the bottom in the labor market was in Aug/Sep 2003 and hiring has been increasing, although slowly, since then. The catch with this report is the reporting period. This is a November period and light years behind the market in terms of revelance. Traders want to know what happened last week not three months ago. This does suggest that data from other more current sources like the ISM surveys will continue to show improvement in hiring and that improvement will eventually end up in the JOLTS data.

There is also the problem with the type of new jobs being created. New Wal-Mart's, Starbucks, Home Depots and new fast food restaurants are creating new jobs faster than the jobs report is showing. This suggests that we are seeing the cheapening of the work force. (no offense to those readers in those professions) I am merely drawing a conclusion that although jobs are being created they are not the jobs most people would be excited about.

The FOMC minutes for December came out at 2:PM and they are credited with the afternoon drop in the market. Not the actual minutes but the fear of the minutes as the drop came between 1:15-1:45. The minutes clearly described why the Fed removed the considerable period statement this month. They viewed it as restricting their flexibility to respond to changing conditions. The minutes were also more bearish in tone with greater worries that inflation could ramp up at any time and they wanted to be prepared to take a preemptive strike if need be. The members also expressed concern for the rising budget deficit and the eventual impact on the economy.

Several members argued to remove the statement in the December meeting suggesting they were getting ready to raise rates and needed to clear the table for the next series of rate hikes. Ugly thought! Instead of an immediate drop they added the phrase associating it with economic conditions to warn the markets there was a change coming. As we know from the past six weeks the markets ignored the warning. That market stance of burying its head in the sand brought the Fed no choice but to change the statement to plain language at this weeks meeting. So much for the soft landing. We didn't listen and they had to hit us harder. The members also expected the unemployment rate to drop over the coming quarters as a result of the rising economy. Now we can see why they were shocked when the December Jobs report was barely positive. In general they are not really worried about inflation and could still see a potential deflationary period ahead. They view the risk to each direction as now equal. They just wanted to be ready to react if the inflation monster won the battle and sprang from the bushes. With capacity utilization still at 75% the odds of impending inflation are very slim.

Bonds finished flat for the day and after the ramp job yesterday it is amazing we did not see a sell off. It is even more amazing when you consider there is $80 billion in new supply coming to market through next week. The government has to fund that deficit and somebody will get the interest.

The market reaction to the Fed news both in bonds and equities was over done in the opinion of most analysts. However, while nobody thinks they will raise rates soon it is the discounting process that we are seeing now. When the Fed was seen to be on hold until 2005 the markets had factored in that lack of change for the next 6-9 months. That is exactly what the markets are supposed to do. They factor earnings, rates and economic prosperity for 6-9 months in advance. A change in one prompts a change in the others. We need to also remember that rate hikes do not come one at a time. The Fed is not going to raise 1/4 point and then go dormant for a couple years. They raise for a reason and every rate adjustment takes 6-9 months to work its way through the markets. Normal cycles involve 3-5 rate changes over an 18-month period. So, the markets are not just factoring in a potential rate hike in May, which is the new target, but they are factoring in the entire rate hike cycle which could begin in May. See, it really is a trend change in progress.

The good news is the reason for the hikes. If the Fed does hike rates in May it will be because the economy has exploded fast enough to generate inflation. Think about that. We are currently crawling along in terms of economic growth that we can see as in job creation. However earnings are exploding. We are seeing raised guidance by the majority of companies and the body language of the confessors is positive. They are not hunkered down behind their figurative podium in flak jackets when they announce. They are generally proud of the results and optimistic about the future. This is a complete change from just six months ago. The bottom line is that the growth has to expand significantly from even the current level to invoke a rate hike and at the present rate that may not happen anytime soon. The message to the markets should be don't get yourself in a tizzy because nothing fundamental really changed.

However, there was a major change in the tone of the stock market. We have had three major distribution days so far this week. Strong volume with declining volume substantially higher than advancing volume. New 52-week highs on Thursday were 274 and a level not seen since October 24th. The semiconductor sector crashed to a support level not seen since early December. The SOX broke its 50 dma at 515 and came within two points of next support at 500. Considering chip stocks were up the strongest of any sector over the last few months it is no surprise they were the hardest hit. In fact the SOX lows on Thursday were more than -10% off the January highs. A REAL correction!

SOX Chart - Daily

The Russell also took it on the chin with a -5% drop back to 573.00 from its 601 high from Tuesday. A -5% drop in three days is a significant hit. Putting it in perspective the Dow barely blinked. We saw a drop back to 10417 intraday on Thursday and close enough to 10400 to call it a successful test of support for me. That was only a -2.7% drop from its 10705 high from Monday. The real damage came from the Nasdaq, which dropped -112 points from its 2152 high on Monday. I say real damage because that was a -5% drop on a highly visible index. Remember this is on mostly better than expected earnings. The afternoon rebound on Thursday was simply an oversold reaction in front of the GDP report and not necessarily a sign that the worst is over.

Ok, now what? The key is the GDP report on Friday morning. It also helps that we have the NY-NAPM, Chicago-PMI and Consumer Sentiment at the same time. If I had to take an unbiased look at just the indexes and predict a direction without factoring in the bullish sentiment I would expect at least one more down day in our future and maybe several. None of the major indexes have even come close to their real support at the 50 dma except the SOX. The levels for the respective indexes are:

Current - 50-dma

579 - 558 Russell
1094 - 1134 Spx
2068 - 2005 Nasdaq
10510 - 10208 Dow
11045 - 10661 Wilshire 5000

The SOX is the only major index of note to break its 50 dma during this sales event. Based on simple technical analysis and recent historical trends the major markets should all test that level. But, we still have to factor in the bullish sentiment and economic conditions.

Basically the conditions are good and the sentiment is still off the wall bullish. The economic conditions will be tested over the next six trading days with a barrage of reports ending in the Nonfarm Payrolls next Friday. These reports will either push the rest of the undecided sellers off the fence or convince the dip buyers to go shopping for bargains.

The GDP on Friday is the first big motivator. The real consensus estimate is about +5.2% with the whisper numbers still running around +6.5%. We have to assume the Fed knew the GDP numbers in advance and factored them into their statement. If the GDP was weaker than expected would they have wanted to roil the markets only to have them tank again two days later when the GDP was released. Stranger things have happened but I am not expecting it. If we do get a decent GDP I would expect the markets to react favorably. Friday is also month end and I would expect some window dressing from funds with excess cash on hand. I would expect that window dressing to trigger some short covering from those who profited from the drop. A bad GDP will just add fuel to the profit taking fire.

Obviously this is all speculation and anything is possible. We are well off the highs but also well above normal support. That gives us plenty of room to wander without breaking any real support or resistance levels. We can remain range bound within a broad range until after the Jobs report next Friday. I would then expect the markets to go directional once again. While I could rationalize a touch of the 50 dma on all the averages I would be very surprised to see it. When you consider I have been looking for a -500 point Dow pullback since Jan-1st that should give you some idea of my current mindset. I can see us moving lower, I would just be surprised if it was that much lower given the current sentiment. I have said all along there was a buying opportunity in our future and this is it. About the only thing that could ruin it for me would be a massive negative surprise in the economic reports. I am betting against that possibility and went long on the dip today.

Enter Passively, Exit Aggressively.

Jim Brown
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