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Market Wrap

What a Week!

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       WE 03-12        WE 03-05        WE 02-27        WE 02-20 
DOW    10240.08 -355.47 10595.5 + 11.63 10583.9 - 35.11 -  8.82 
Nasdaq  1984.73 - 62.90 2047.63 + 17.81 2029.82 -  8.11 - 15.63 
S&P-100  549.92 - 18.53  568.45 +  3.91  564.54 -  0.33 -  1.05 
S&P-500 1120.57 - 36.29 1156.86 + 11.91 1144.95 +  0.84 -  1.70 
W5000  10968.18 -346.24 11314.4 +141.50 11172.9 + 29.34 - 30.42 
SOX      485.10 - 19.15  504.25 +  1.99  502.26 -  7.99 -  0.80 
RUT      582.84 - 16.70  599.54 + 13.98  585.56 +  5.67 -  5.25 
TRAN    2863.09 - 29.98 2893.07 -  9.12 2902.19 + 10.01 - 24.38 
VIX       18.30 +  3.82   14.48 -  0.09   14.57 -  1.47 +  0.46 
VXO       18.72 +  3.92   14.80 +  0.04   14.76 -  1.49 +  0.62 
VXN       25.30 +  3.22   22.08 -  0.79   22.87 -  1.25 -  0.02 
TRIN       0.44            1.40            1.26            1.29  
Put/Call   1.05            0.79            0.73            0.86  

Last Sunday we were jubilant that the Dow managed to close up on Friday and right at 10600 after the disappointing Jobs report. This Sunday we are just thankful we did not break Dow 10000 again. Definitely not the kind of week we have seen in 2004. Actually it has been 19 months since we have seen a week this bad.

Dow Chart - Daily

Dow Chart - 5 min

Nasdaq Chart - Daily

The lack of any materially negative economic reports and the lack of any new terrorist news resulted in a strong rebound from grossly oversold conditions. We will need a couple more days of trading to find out if this was the end of the correction or just an oversold bounce but nobody was heard complaining on Friday.

The economics we ignored included the Business Inventories that rose only +0.1% and less than estimates of +0.3%. This was widely expected to miss the estimates after the weak Wholesale Trade report. The inventory to sales ratio remained at record lows at 1.33 and it is only a matter of time before inventories have to be replenished. Growth in most components slowed with only Manufacturers posting a minor gain. Sales were still increasing only at a slower rate. Should inventory levels not pickup quickly the GDP for Q1 could see a sizeable drop.

The Current Account balance increased due to strong income flows into the US during the 4Q. This was surprising and when taken as a percentage of GDP it has shows gains, a decrease in the outstanding liability, for three quarters. Both imports and exports improved during the quarter. No complaints here.

The most surprising report was the Consumer Sentiment which was inline with estimates at 94.1 and only slightly off the February levels. Considering the falling sentiment/confidence levels for all of February a flat report showing a firming of sentiment was surprising. This may be the last positive sentiment report for several weeks. The polling was done for this before the Intel guidance, weak Jobs report, the terrorist attack in Spain and the stock market correction. Once consumers are polled after those events there could be a significant change. In Friday's report the present conditions component was 105.7 and up from 103.6 in February. This was probably a result of the strong market and the hype over strong jobs expectations two weeks ago. The expectations component fell to 86.6 from 88.5 which was probably related to the increased economy bashing in the presidential campaign. The constant reference to jobs being lost from outsourcing probably weighed on workers minds. As the quarter progresses tax refunds and bonuses should help offset some of the negatives.

The rebound on Friday sent many traders home breathing easier. The Dow rebounded +111 points and the Nasdaq +41. Nice gains but if you looked at the header to this article you noticed some very bearish numbers for the week. The Dow lost -355 and the Nasdaq -63 and that is after the gains from Friday. Needless to say it was a very bad week but in reality it was just normal. I know it was painful to everyone who was long but we were due for a drop. It had been 19 months since we had seen a -5% correction and there was plenty of cash waiting on the sidelines for an entry point.

I am going to review both the potential for a continued rebound and a continued drop today and some of the reasons the drop occurred. Despite our personal biases we always need to be aware of things happening in the market. First the market has a tendency to celebrate anniversaries of turning points with another turning point. It seems that prior painful memories tend to resurface in trader's subconscious minds. Actually even pleasant memories tend to haunt the markets.

For instance, March 12th-2003 was the turning point in the markets and marked the low for all of 2003. We have literally moved almost straight up since that day. March 10th-2000 was the absolute high point for the Nasdaq at 5132. March-11th 2002 was also the high for all of 2002. I could stop there and rest my case for a potential market anniversary event in March of 2004 but it would have been pure speculation and posses no technical justification. To apply justification we add the historical fact based on research done by Ned Davis that cyclical bull markets tend to last about 12-15 months and tend to rebound about 50% from the bear market lows. This may or may not be a cyclical bull market but either way the tendency to correct at those levels even if only temporary remains the same. Obviously time frames are always vague depending on sentiment, earnings, interest rates, current events, etc. The most critical factor is the +50% gain off the lows. From the October low at 768 and the March low at 788 I was using the +50% target for my cautions of a January dip at 1175. A +50% gain from each low would have produced 1152-1182 as a target. I settled on 1175 which was the double top resistance high in March-2002. Notice how those March dates continue to appear? We reached 1155 in January. It took six weeks from the Jan-26th 1155 high to push only +8 points higher to the 1163 high on March-5th. In retrospect I missed the eventual high by 12 points. The extreme bullish sentiment in January simply refused to capitulate but that is not the focus of this commentary. The problem as I see it today is where are we in the grand scheme of things. Are we going back up or back down?

SPX Chart - Weekly

The argument for a rebound to the highs is based on earnings, interest rates and the current economic recovery. I heard again on Friday that First Call is now expecting earnings for the first quarter to be in the +15% to +17% range. Their current hard estimate is +14.9% and rising. This would tend to suggest stocks should continue to go up as long as earnings continue to climb. The Fed is on hold and mortgage interest rates are plunging to lows not seen since last year. This is good for home and auto sales and could bring another round of refinancing and that money eventually finds its way into the economy. Tax checks are starting to flow and the economy is continuing to recover, maybe. All I need to do is break into a rendition of "Happy days are here again" to solidify this warm fuzzy feeling.

However, and you knew there was a however, we all know the market discounts future events 6-9 months out. Stock prices today are based on those expectations of Oct-Dec conditions. If we look into the future we see much stronger comparisons for earnings. Remember the blowout Q3 and Q4 in 2003? Unless this recovery catches fire and I mean roaring fire really quick the earnings comparisons for Q3 and Q4 for this year are going to start shrinking. Instead of +15% growth it could drop to single digits and that would really sour sentiment.

We are also reaching the point where the dollar cannot continue to go down. Eventually the strong dollar will begin to reassert itself and that will hurt earnings. For instance over half of Oracle's growth in database sales for last qtr was from gains in currency translation. License revenue grew +13% and currency gains accounted for +7% of the total revenue and +8% of the new software growth. What will happen when the dollar begins to strengthen again? Weaker earnings for most multinational companies.

We also have the already questionable recovery. Almost every economic report continues to show growth but the pace of growth continues to slow. This is troubling quite a few analysts. The lack of job creation is also a problem. I know it is a lagging indicator. I got the memo. But, even lagging indicators eventually have to confirm and jobs are the weakest of our current indicators. The current debate on outsourcing is bringing the problem more to the forefront than ever before. Are we in a growing recovery or has it already peaked?

The massive explosion in the bond market over the last week and the drop in yields was far in excess of what should have been expected from the weak jobs report. There is a real undercurrent in the analyst community that suggests there are more problems in the system than anyone expected. There are moves underway to find the change in the current environment that is consuming jobs. The fear is that what worked before may not be working now and nobody knows why. The inordinate rise in bonds has spooked economists, politicians and stock and currency traders alike. Can you have too much of a good thing? Evidently you can if nobody knows why it is happening.

The terrorist attack in Spain and the bogus claim of responsibility by the Al Qaeda cell may have had a serious impact on our already spooked markets but that has passed. The terror war may eventually return to our soil but the real war that will impact our markets is the political one. The battle will be waged on the airwaves and the outcome is far from clear. The surveys made public early last week may have had more impact on the markets than people realize. Projections that Bush had lost his commanding lead and was running a dead heat or possibly even behind Kerry threw institutions into a tizzy. The potential for a change in power and a repeal of the tax incentives caused a sudden rethinking of strategy. The previously unthinkable after Bush had soared to enormous satisfaction ratings had now become possible.

Historically the fourth year of a presidential term is a positive year for the markets. The party in power uses every means at their disposal to remain in power. That includes tax cuts, social security increases, big jumps in spending including doling out pork projects like manna from heaven. Also, historically the first two years of a second term have spawned many of the worst bear markets on record. Specifically 1929, 1937, 1957, 1969, 1973, 1977 and 1981. You can't give away the candy store in an election year without paying for it eventually. Taxes get raised, budgets cut and all the unpopular work gets done. During a second term the president does not have to worry about getting himself reelected but tries to clean up conditions quickly so his party's successor has a chance of victory.

So where does all this confusing and conflicting information leave us? Are we going back up or back down? Wouldn't we all like to know? Unfortunately there is no clear answer. The market "should" rebound into the April earnings cycle because the earnings growth is still expanding. It "should" begin to decline into the summer as the earnings comparisons become harder and the election mud slinging heats up. "Sell in May and go away" has been a market maxim since before I was born. This puts investors on the sideline during the summer doldrums and safe from any inadvertent market moving campaign comments. When politicians are running for office nothing is safe. Drug companies could be hit by controls. Energy companies, health care services, defense, no one is safe from attack if it will score more votes.

The problem would be easier to solve if the recovery would simply catch fire. A roaring economy covers many sins. The deficit would slow, taxes would flow, employment would rise and workers would consume goods. Unfortunately the recovery is still missing in action on many fronts. We saw what $365B in tax rebates and the lowest mortgage rates in 45 years did for the economy in Q3-2003 but nobody expects any more miracles in 2004.

I think all of this leaves us with a negative bias after April unless we get a major economic surprise. That means any rebound next week may only be temporary. According to the Stock Traders Almanac next week is bullish with a triple witching options expiration on Friday. That is great news because we need to rebuild trader confidence if we are going to have any April earnings run. Our mid quarter update cycle is nearly over and next week will begin the warning cycle. So far there have been very few early confessions and hopefully this trend will continue.

Technically the Dow has resistance at 10300, 10450 and much stronger resistance at 10600. The 10600 level was the center of the recent trading range and it is highly doubtful we will exceed that level any time soon in our weakened condition. That means the Dow could be forced to define a new trading range with 10500-10600 on the upside and 10000 on the downside. Right now we are still oversold despite the +111 point gain and we are probably going to move higher next week. How high is a matter of debate.

Where the Dow just suddenly fell out of its range the Nasdaq has been trending down since late January. This suggests a different type of problem. The Dow contains materials stocks, financials, consumer cyclicals, techs and manufacturing stocks. All solid blue chip companies and places where funds can park money in times of uncertainty. The Nasdaq has a different problem. In times of uncertainty traders tend to flee highly volatile tech stocks and move to safety. This is why the Nasdaq typically leads any drop and has deeper corrections. The percentage drop from the highs for the year on the Nasdaq is twice the Dow percentage and right at -10%.

The Nasdaq has resistance at 2000, which is also the 100dma and again at 2030 to 2060. With the downtrend in progress since Jan-27th it is going to be tough to get back over 2050. That level was the price magnet for the two weeks prior to the current drop and is now strong resistance. The Nasdaq also has strong support at 1900 and heavy congestion between 1900 and 2000. This suggests the Nasdaq could also be locked into a new range from 1900-2050.

I know this commentary probably angered some readers and bored others but it is the kind of fact summary that we all need to consider. I would like to think we will reach new highs before May and nothing would please me more. Unfortunately the current market environment is not suggesting that will happen.

The drop this week was not unreasonable in its depth as all indexes dropped approx -3.5%. Just a normal correction and one that should be over. What shocked investors was the dramatic way it dropped. This also suggests that investors are worried. Instead of a calm decline the drop was sudden and sharp with signs of panic.

For me the strongest indication of strength on Friday came from the Russell. The little index that thought it could roared back up the hill and posted a +14 point, +2.47% gain. This was a monstrous move when put into perspective. The Dow gained +1.10%, Wilshire +1.35% and Nasdaq +2.10%. The Russell was the motivating factor behind the Nasdaq gain. The closing Russell sprint added +5 points to the Nasdaq in the last 8 min of trading. The Russell was the ONLY index to not break its bullish uptrend support for the week.

Russell-2000 Chart - Daily

The rebound on Friday came on very strong internals with up volume 6:1 over down volume and advancers 5:2 over decliners. Traders would have been cheering at the close were it not for the very low volume of only 3.7B shares. This is not what builds investor confidence. The drop on Thursday was on very strong volume of over 5B shares and 4:1 down volume to up. Everything was in place for the rebound but that vital volume component. My theory is weekend related. With the renewed terror risk I feel investors were willing to wait until Monday to avoid weekend event risk. That makes Monday a critical day for the bulls. We must rally on strong volume and strong internals to rebuild confidence in the market.

That may be a tall order for the Dow with resistance just overhead at 10300. It fought 10225 all day and was only able to break back above its 100dma at that level in the last ten minutes of trading as shorts covered into the close. The Nasdaq has about 20 points of free space before running into resistance at 2000 and only if it can open in positive territory and over resistance at 1980. We could win back a lot of traders with a blast out of the gate and a push back to 10350/2000 or higher on Monday. Conversely if we are unable to push higher then Friday will be seen as a simple oversold relief rally and the overhead pressure will begin to build again.

The economic reports on Monday are neutral and should provide bullish confirmation with the Housing Index and Industrial Production. Marginally weak numbers should not be seen as negative to the market. The NY Empire State Manufacturing Survey has been on a steady uptrend and one of the few reports consistently gaining strength. The February number was a record high so any pullback will just be seen as a pause and any higher number is a new record. Not much risk there.

Next week is going to be critical to the market for the rest of the quarter and the base for any April earnings run. We must have a couple of good days beginning with Monday or traders will begin rethinking their plans with many electing to take profits and leave early for the summer. Normal profit taking does not cause alarm but extreme uncertainty does. With our uncertainty quotient growing daily we need a booster shot of confidence to get us over the hump. The inoculations will begin at the bell on Monday.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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