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Market Wrap

Trend Change!

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      04-29-2004           High     Low     Volume   Adv/Dcl
DJIA    10272.27 - 70.30 10407.97 10219.18 2.30 bln  850/2400
NASDAQ   1958.78 - 30.80  1998.02  1946.10 2.37 bln  830/2362
S&P 100   544.54 -  3.30   551.53   541.69   Totals 1680/4762
S&P 500  1113.89 -  8.52  1128.80  1108.02 
W5000   10867.10 -100.30 11008.24 10811.96
SOX       450.48 - 11.80   464.46   443.74
RUS 2000  567.25 -  9.81   580.45   564.44 
DJ TRANS 2904.06 - 43.10  2964.52  2890.85   
VIX        16.60 +  0.31    17.27    15.87
VXO (VIX-O)17.30 +  0.58    18.01    16.23
VXN        24.90 +  0.98    25.51    23.95 
Total Volume 5,147M
Total UpVol    825M
Total DnVol  4,174M
Total Adv  5410
Total Dcl  1900
52wk Highs   98
52wk Lows   300
NasTRIN    2.13
TRIN       1.24
PUT/CALL   1.00

It only took two days but the trend is on the verge of a drastic change. The Dow hit 10537 on Tuesday and 10219 today. In only two days the Dow has moved from the high end of its range to the very low end of its range for the entire month. The earnings sentiment has gone from very bullish to very bearish despite any material change in the earnings. Fear of the Fed, trouble in Iraq, decline in China and election fears have all been given as excuses. Which one is it?

Dow Chart - Daily

Nasdaq Chart - Daily

The morning started out good with Jobless Claims dropping back below 350K to 338,000 and moving back to the level we saw in March. Something to do with the Easter holiday had bumped the numbers back over 350K for two weeks but that anomaly appears to have passed.

That was the extent of the good news. The Employment Cost Index rose faster than expected at +1.1% pushed higher on soaring benefit costs. Those costs jumped +2.4% for Q1 and nearly double the costs for the prior three quarters. Benefits for blue collar workers rose +3.8% and +4.2% for manufacturing workers. This is a very strong jump for benefits where most of the cost is due to rising healthcare. The wage component rose only +0.6% and it was the slowest growth rate recorded to date! That suggests the labor market is still very soft and employees have no leverage in negotiating wages. This was not good news for the employment picture or for future company earnings if the trend continues.

Confirming the weak employment market was a drop in the Help Wanted Index for March to 39. It was not a big move but it did reverse the minor uptick from the prior month. It appears there was some pickup in job advertising in February as the new year got underway but that may have only have been a blip. Not an earth shaking report compared to those we have next week but still another crack in the economic outlook.

The biggest economic blow for the day was the GDP which only posted a +4.2% gain in the most current estimate. Consensus estimates had been in the +5.2% range with whisper numbers nearing +6%. Suddenly all the constantly improving bullish comments on the economy imploded and with it the expectations for surging stock prices. All things considered the +4.2% rate is very good. Everyone would be very happy to maintain that rate for several years but the problem was expectations. The market had priced in expectations of 5.2-5.5% or more. The constant buzz about the very strong Q1 earnings had investors thinking the revised GDP for the quarter was also going to be very strong and surprise to the upside. Instead the surprise shocked everyone back to reality. Business is good but not great and harder times lay ahead.

That reality is also creeping into earnings. As of last weekend 78% of companies had beaten estimates for Q1. As of today that number is down to 76% and still very respectable. The problem is the guidance. As we get deeper into the earnings cycle the quality of companies reporting declines and we are getting fewer upside surprises and more downside guidance. The common report is now predicting stronger comparisons ahead.

I have been cautioning you that this would happen but when the markets are near their highs and the bulls are running nobody wants to face facts. The underlying fact is simple. The economy boomed in late 2003. Remember that +8.2% GDP in Q3-2003? The Q2-2003 production cycle is what pushed us to much stronger earnings and output in Q2, Q3 and Q4. That ramp up on the very large tax rebate program in 2003 pulled us out of the depths of recession and boosted us into high gear. We hit full speed in late Q3 and quickly ran out of tax rebate fuel. We posted a GDP of 4.1% in Q4, normally a strong quarter and have been coasting through Q1 at that 4.1% rate. Companies were hoping to pit stop in Q1 and pickup some more tax refund cash to spur buying but as I have reported previously those refunds shrank to about 1/4-1/3 of what was expected. Now we are faced with the summer doldrums ahead and no gas in the economic tank.

Obviously that is a greatly simplified picture and not exactly correct but I think you get the idea. The good news from the lower GDP is no urgency on the part of the Fed. They were about to go into attack mode if we had broken out over +5% and that threat has been neutralized. We have several more critical economic reports over the next several days and the Fed meeting on Tuesday but the decision should already be over. Odds of a rate hike in May or even June just went to near zero.

The market obviously did not celebrate that fact. The market opened down and then rallied slightly on a single buy program on the Help Wanted news and then crashed. Whoever pulled the trigger on that buy program was probably celebrating the Fed knockout but when the keg ran dry he found himself the only one at the party.

Falling expectations trumped the falling chances of a rate hike. Stocks that had been highly leveraged on the chances of a strong economic explosion suddenly found themselves over priced for a return to a slow growth environment. Semiconductors, techs and small caps were dumped with no hesitation. Helping fuel the fears of an economic slow down were comments from China that the government was going to take "strong" steps to slow down its overheated economy. Commodities dropped like a rock on Wed when the comments were made. China has been on a ferocious pace with growth at a 9.7% rate. They have been sucking up gold, silver, copper, oil and almost every manufacturing material in excess of current supply. Prices had been soaring. The potential for China to suddenly slow rippled through all the markets. This ripple was hardly warranted. The target growth rate for China is +7.1%, hardly a recession. China's growth can be slowed by the Premier taking strong measures as he has said but it is not going to stop tomorrow. We all know it takes months if not years to see any impact from economic brakes. The greed factor is alive and well and it will always find a way to prosper if buyers are available. Yes, comments from China did hit our markets over the last couple days but the real impact is more imagined than real for the time being.

Iraq and Israel were also used as excuses for the depression in the U.S. markets. I would hope that anybody investing real money is intelligent enough to know there has been and will be fighting in those countries until hell freezes over. Sure, news that ?? American soldiers were killed on any given day is still very troubling but it is not something that should tank the market by triple digits.

It all boils down to earnings and profits. Polite conversations about the merits of particular stocks and the potential for the next rally are held daily in institutions and across supper tables. They remain polite as long as the uptrend remains intact. Many funds, institutions and private traders have huge profits on the table from the March rebound last year. The Dow 100 dma was not touched from April through February. It was broken in March but quickly recovered. Trigger fingers relaxed and traders with huge profits began to breath again. It was broken again on the 21st but a rebound the next day put traders back at ease. However, we all know the adage, once bitten twice shy and the markets have been bitten several times lately. The markets have been very nervous for the last couple of weeks. Traders continued to hope for new highs to confirm the economic expectations and their justifications for continuing to hold profits from the 2003 rally. Unfortunately since the current high for the year was set on February 19th we have seen a steady progression of lower highs. Tuesday's push to 10537 was the culmination of two weeks of gains but it was still a lower high and one that was only 131 points over the 100dma. Once that high failed with no attempted rebound the rats began deserting the ship.

That desertion turned into a rout on Wed/Thr. Volume made new highs for the year and it was extremely negative. On Wednesday volume across all markets was 4.9B shares. 4.2B was down volume with only 606 million shares of up volume, a 7:1 disadvantage. On Thursday volume hit 5.2B shares, a record for the year, and down volume was 4.2B with up volume only 829 million, 5:1. The new highs/new lows number was also a disaster. Only 99 stocks hit new highs and 303 hit new lows. To put this in perspective that is the first time new highs have been under 100 since March 24th, 2003. It is the first time new lows have been over 300 since March 12th, 2003. That just happens to be the day the Dow broke under 7500 and set the low for 2003. I want to make sure this is clear. The new high/lows for today were as bad as the day the Dow was at the low for 2003. The difference is about 2750 Dow points. We should not be seeing these kinds of internals at this level in the market. This is serious but it does not mean it will continue.

The Dow has dropped nearly -300 points in three days. It closed today at 10272 after touching 10219. This level is very critical. 10300 has been the bottom of our range since March 29th. However, if you remember the March drop took us to 10007. There is still a technical possibility that we could hold here or at the March lows near 10000. I say technical possibility because the sentiment has definitely changed. It is one thing to predict higher moves when all the earnings and economics are improving but once the dominoes begin to fall the change in sentiment accelerates quickly. I am not going to sugar coat this. We are at a critical point in the market. We could continues to go either way but the path of least resistance is definitely down.

The Nasdaq also broke critical support today and has fallen -100 points since Monday. Further support remains at 1940 and again at 1900 but the outlook is not good. Taking the Nasdaq down is the semiconductor sector which broke final support on Thursday and sank to a six month low. Take a look at the SOX chart and the risk to the overall market will be quickly apparent.

SOX Chart - Daily

Russell 2000 Chart - Daily

The last twig on the cliff that the bulls can cling to is the Russell. Small caps have been taking a beating this week and the Russell is on the verge of breaking that last critical support at 560. We have been near this level four previous times since January and each time there was a miraculous recovery and it could happen again. Unfortunately the chart is not suggesting that for tomorrow.

Before I get too bearish we all need to remember that market events run in cycles and this cycle could just be an over reaction to the changing trend. We have serious economic events in our near future as well as a Fed meeting and the GDP today was a warning. Actually it is unrelated to any of the economics we will see over the next week but it did take some of the complacency out of the economic expectations. We have had two very negative days in the market. It may be time for the bargain hunters to rush into the gap but there are no indications yet that it will happen tomorrow.

I have been telling you to sell the tops and buy the bottoms as long as we remained range bound. I suggested selling the 10500-10550 top of the range as recently as Tuesday. On Sunday I suggested a break of this trend would be a move under Dow 10250 and Nasdaq 1975. Both of those levels were broken today. The Dow regained some ground to close back above 10250 but only slightly. The stage is set. Another drop at the open and the bulls could be heading for summer pasture. While nobody would expect the market to roll over and die it could be a rocky month ahead. The majority of the initial damage has been done and after Friday we could move sideways until after the Fed meeting. If we rebound from 10250/1975 I would be very cautious about going along for the ride.

Enter Passively, Exit Aggressively.

Jim Brown
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