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Market Wrap

Too Much Good News

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      04-13-2004           High     Low     Volume   Adv/Dcl
DJIA    10381.28 -134.30 10552.61 10361.99 1.79 bln  397/2913
NASDAQ   2030.08 - 35.40  2073.42  2026.20 1.95 bln  718/2478
S&P 100   552.24 -  7.25   561.05   551.33   Totals 1115/5391
S&P 500  1129.44 - 15.76  1147.81  1127.70 
W5000   11046.02 -166.80 11237.32 11029.52
SOX       506.25 -  9.00   517.62   505.01
RUS 2000  585.83 - 13.82   601.04   584.34
DJ TRANS 2890.71 - 43.10  2948.19  2884.40   
VIX        17.26 +  1.98    17.98    15.29
VXO (VIX-O)17.50 +  2.06    18.06    15.47
VXN        22.23 +  1.86    22.52    20.26 
Total Volume 4,097M
Total UpVol    739M
Total DnVol  3,320M
Total Adv  1323
Total Dcl  6085
52wk Highs  308
52wk Lows   121
TRIN       1.22
NAZTRIN    0.88
PUT/CALL   0.92

Analysts would have you think the reason for today's drop was too much good news. Higher than expected Retail Sales and higher than expected Business Inventories were said to have increased fears of higher interest rates and that caused the sell off. Think about it for a moment. With rates at multi-decade lows why would two minor reports suddenly turn the markets upside down? Not hardly.

Dow Chart - Daily

Nasdaq Chart - Daily

Russell 2000 Chart - Daily

S&P Chart - Daily

The weekly Chain Store Sales rose by +0.8% but the real heat came from the March monthly numbers with a +1.8% gain. This was more than double the expectations of +0.5% to +0.7% and suggest consumers are racing to the store with their tax refund checks. After the stronger than expected number the markets gapped open to strong resistance at 10550/2075/1150 and instantly failed. You will not make me believe that the good news from 8:30-9:30 turned instantly to bad news at 9:40. The component with the largest gain was Building Supply stores which soared +10.6%. The year over year gain was a record +20.8%. You would think this component would be seen as positive for the housing impact. Food service and Electronics both rose over +10%. Again, this was very good news for the economy.

The reason for the sell off was given by the talking heads as the news was too good and would lead to rapidly higher interest rates. While I agree the news was good it is only one piece of the puzzle. We have been looking for some sign the consumer was not hibernating and this was it but nobody expects the Fed to come out tomorrow and raise rates. There was also the viewpoint that such good sales would project weaker numbers over the next couple months as the tax refund bubble burst. This is entirely possible but wouldn't that be a reason for the Fed to be patient? Gotcha.

Other economic news was the Business Inventories, which rose +0.7% and slightly over the +0.5% estimates. Good news BUT the sales component rose slightly as well and the inventory to sales ratio remained at its record low of 1.33. Good news but far from great. The Richmond Fed also rose to 30 from 19 and employment gained for the second month. Shipments rose +11 points to 30 and the highest level since July-1999 and new orders rose to 28 from 20. Good news but it is only one Fed district.

Taking all of the above into context produces the following quandary. Only the Retail Sales number was known at 9:30. The markets had already given back their opening gains and were well into negative territory before the Business Inv and Richmond Fed Survey were known. You can't blame them for the drop. The trend was already in place and strongly negative.

Was it earnings that started the slide? Not hardly! Dow component JNJ reported a +20% surge in profits and they beat estimates by +3 cents. Merrill Lynch reported record earnings of $1.22 per share and almost twice the same qtr last year at 67 cents. Revenues were up +27% from Q1-2003 and +25% from 4Q-2003. No bad news there.

Something was clearly afoot that triggered the very strong sell programs at the open. Personally I think it was several factors at work. First is option expiration. We have had no material volatility for this expiration period. Volume on Monday was the lightest day of the year and not a normal expiration Monday. Traders came back from the holiday weekend with selling on their mind and analysts were quick to try and place blame. Another reason for the selling was tax related. Traders with substantial profits from the 2003 rally needed to raise cash to pay the taxman on Thursday. It was a very good year for traders and the outlook for stocks over the next six months is not exciting. Time to take profits, raise cash and pay the piper. Last week mutual funds only saw positive cash flows of $2B and this was a quarter end period and the end of the 2003 contribution period. That was not a good sign. The selling today suggested funds were seeing substantial outflows this week. The Russell 2000 literally fell off a cliff and traded -17 points off its opening high and lost nearly twice as much on a percentage basis than the Dow. This is a clear sign of fund withdrawals.

Other challenges facing traders were the Intel earnings report tonight and the Bush press conference. Traders heard that a group of hostages had been found dead in Iraq and 40 more were in captivity. April has been a horrible month with 78 coalition soldiers killed so far. Bad news was breaking out all over but I still feel expiration and cash flow were the key. Intel, Bush and the war were just added weight.

After the bell Intel disappointed but only barely. Since it had been widely expected to announce soft earnings there was no real after hours impact. Revenue was light and Q2 guidance was light. They said processors, chipsets and motherboard sales were lower than expected but flash memory sales were slightly higher. Unfortunately flash memory has been a profit problem for Intel. Futures fell about -3 points in after hours. No big deal and Intel only fell about -40 cents. Andy Bryant said on a TV interview that they were seeing consolidation of the gains for the last three quarters and were not seeing new economic growth. He said mature markets segments would continue to expand IF IT spending grew and IF the economic recovery continued but not at the rate seen in the prior three quarters. Intel had very respectable earnings at +$1.73B. Unfortunately I think quite a few traders were hoping for an upside surprise. Investors have been used to constantly rising estimates and two quarters of lowered guidance is a disappointment to some traders regardless of how well they really did.

The Bush press conference tonight is his first since the war started in Iraq and he is expected to restate his case for being there and announce that 20,000-40,000 troops will not be allowed to return home as scheduled. It is a "press" conference and not a speech so anything will be fair game and he is bound to get some hardball questions on everything and some traders may have wanted to see what pops up before buying the dip. The pictures on TV of burned Americans hanging from bridges has brought the war back home and the 70+ soldiers killed this month is the worst since the war began and the month is only half over.

Stock news is booming and it would be very hard to pin any market weakness reasons on the current earnings cycle. Unfortunately we all know the markets discount six months in advance. First Call is now projecting as much as +21% earnings growth for Q1. This is the third consecutive month over 20%. Very strong performance but it is already priced into the market. First Call is also projecting earnings growth for Q2 at +15%, Q3 +16% and Q4 +14%. These levels are strong but far below the last three quarters and far below the current 20% rate.

The problem is the calendar. The first quarter last year was a pre-war quarter and earnings were very depressed. Here we are a year later and we are measuring our "booming" results of +21% growth over a quarter that was a pothole in history. Once the war was "over" business started booming and we ramped up into the monster 3Q on the strength of monster tax rebates. Comparisons are going to get a lot tougher as we compete with that 8.5% GDP rate from Q3-2003 with a +4.0% GDP rate in 2004. The weak Intel guidance tonight suggests IT spending going into Q2 is decent but not booming. Ashok Kumar said this week the PC/IT growth for the rest of the year would be hard pressed to pass +4% and much less than the +10% some have suggested.

Technically we were due for a test of strength despite the other external factors. For seven straight days the Dow tried to rally and hold over 10500 with no success. This sets up the potential for profit taking as traders tire of trying to push it higher. The Dow pulled back to near support at 10350 with stronger support at 10300. This is not the end of the world but you may be able to see it from here. This drop gives us a potential completed lower high and a drop under 10300 would confirm it. We are in a critical area. We need to rally quickly from here and break out to the 10600 level or the selling volume will quickly escalate. Once the bulls decide there is not going to be an April earnings run they will head for the corral to rest up for fall.

The Nasdaq also tried for seven days to break 2075 and could not make it happen. The -35 drop today was serious but not yet severe. The April 2nd gap from 2010 has not even been filled. The 50dma is 2017 and well below our 2030 close. The Nasdaq is in better shape than the Dow but the same criteria applies. A drop back below 1980 would put the bulls out to pasture.

The market internals were very bad with decliners beating advancers 4:1 and down volume nearly 5:1 over advancing. New 52-week lows hit 121 and the highest single day level since August 4th. There was definitely a change in sentiment that was not due entirely to rate fears.

The interest fear that was blamed for today's selling is not unfounded but it is greatly exaggerated. The Fed Funds futures are still not targeting a rate cut until September and then only a quarter point. Heck the ten-year yields have almost doubled that in the last two weeks. The fear of rate hikes has done far more damage than any real hike will ever do. Talk is cheap and the Fed heads have been doing a lot of it lately.

For the rest of the week earnings will continue to flow with 70 S&P companies announcing this week. The next big tech to report is IBM on Thursday and there are a flood of chip stocks reporting tomorrow. Some of the notable reporters for Wednesday include AMD, BAC, AAPL, DHI, DAL, ETN, EXTR, LRCX, MTG, RMBS, SNDK, SGR, TXN and PGR. The problem as I see it is not earnings but cash flow and future expectations. If the lowered guidance from Intel is a symptom of future earnings releases then traders still in the market will lose interest. The cash flow numbers for the week will be critical and there is no second chance. Fund flows after April 15th typically slow to a dribble as summer approaches. Tomorrow we also have the Consumer Price Index and traders will be look for signs of inflation that would accelerate any rate hike schedule.

For the short term we are slightly oversold and could rebound at the open but it is still an expiration week and still income tax week. This suggests we could see some more weakness. We also have the increasing war in Iraq and it is finally beginning to drag on the market. The Bush speech tonight could reassure Americans or it could raise the anxiety level. It will be a critical point as the fight escalates. I would be very cautious about entering new positions until this week is out. The conflicting currents are very strong and there are plenty of icebergs around. Thursday is the 92nd anniversary of the Titanic sinking and I would hope it is not an omen for the markets.

Enter Passively, Exit Aggressively.

Jim Brown
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