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Market Wrap

Inflation Returns

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      05-13-2004           High     Low     Volume   Adv/Dcl
DJIA    10010.74 - 34.40 10074.11  9970.93 1.69 bln 1481/1709
NASDAQ   1926.03 +  0.40  1937.87  1914.10 1.56 bln 1373/1709
S&P 100   536.23 -  0.94   539.39   533.91   Totals 2854/3418
S&P 500  1096.47 -  0.81  1102.77  1091.76 
W5000   10650.61 -  7.20 10713.69 10607.62
SOX       459.57 -  2.30   464.75   455.08
RUS 2000  547.17 -  1.82   552.40   545.00 
DJ TRANS 2859.79 + 12.50  2866.02  2838.00   
VIX        18.86 +  0.72    18.92    17.97
VXO (VIX-O)19.39 +  0.90    19.78    18.41
VXN        28.11 +  0.49    28.33    27.37 
Total Volume 3,597M
Total UpVol  1,642M
Total DnVol  1,916M
Total Adv  3187
Total Dcl  3853
52wk Highs   48
52wk Lows   275
NasTRIN    0.78
TRIN       1.02
PUT/CALL   1.01

Traders worst nightmares began to resurface today with a higher than expected PPI report. The overnight gain in the futures was erased in minutes and the markets opened under a rate cloud once again. It is a picture of things to come as the economy grows so do prices and the Fed can't be far behind.

Dow Chart - Daily

Nasdaq Chart - daily

Russell-2000 Chart - Daily

SOX Chart - Daily

Jobless Claims jumped from 318K to 331K last week and only slightly higher than consensus. No real news there other than the 4-week moving average fell to 336K and the tenth week under 350K. This is the lowest level since the economy began to recover. The trend is continuing to decline and that suggests job creation is still growing. As long as claims remain under 350K per week we should continue to add 175K of jobs per month based on historical norms.

Retail Sales for April fell -0.5%, well below consensus and well below the +2.0% gain in March. The culprit is higher gasoline prices and the undeclared energy tax that is ripping cash out of consumer pockets. Auto sales are dropping with a -1.8% fall for the month and shared the top of the loser list with apparel at -2.0%. Building supply stores also lost ground as rising mortgage rates slow home buying. This was a material change from the +11% gain in March. Sure sounds like trouble ahead. This was the first monthly decline in the headline number since September and helped to fan the flames of worry over the declining consumer. With the summer doldrums ahead the retail outlook is not exciting with oil prices continuing to rise.

Oil prices rose to close over $41 per barrel today, a new 13-year high and spot prices of unleaded gasoline were above the level of the futures. This represents surging demand as the summer driving season begins and suggests some really high prices for the summer. Analysts claim a surge in output by OPEC would not necessarily help demand because all the oil tankers are chartered to full capacity and there is nothing left to press into service to haul oil.

The big report today was the PPI, Producer Price Index, which jumped +0.7% and more than twice consensus estimates at +0.3%. Energy prices were the main culprit once again with the core rate, minus food and energy, rising at only +0.2%. If you do not eat or drive your inflation is only moderate. The talking heads were trying to downplay the headline number but a closer inspection shows the inflation rate of intermediate materials rose +1.37% for the month. Even if you take out food and energy that number rose +1.12%. This is pure inflation and at a high rate. Crude materials rose +3.0% and Foodstuffs rose +3.65%.

This immediately knocked the bloom off the pre-market futures and the Dow opened down -75 points. Fear of a faster than expected rate hike scenario sent the yields on the ten-year note to 4.85% and a new two-year high. Mortgage rates knee jerked to new recent highs and all eyes became even more focused on the June-30 Fed meeting. This is going to be a critical period on the market calendar. The Fed will raise rates and Iraq will be turned over to Iraq rule on June-30th. 2Q earnings begin July 7th with YHOO and the Democratic convention starts three weeks later. Everyone will be handicapping the race as democrats grab the spotlight. The Olympics should begin two weeks after the convention assuming they finish the preparations and terrorists take a holiday. It is going to be a tough news environment over the summer.

Fear of these news events probably had a lot to do with the lack of any follow through from yesterday's rebound. There may also have been some fear of Dell's earnings tonight but Dell did come through and hit their estimates of 28 cents. There were numerous analysts debating the results after the bell and Dell dropped more than $1 in after hours trading. There were as many excuses as there were analysts but the main sticking point was a drop in margins. Higher Dram costs and faster growth in lower margin businesses impacted the overall margin. Not a big deal in my opinion. Dell like Cisco has grown so large that they lack any real earnings leverage and are forced to grow the old fashioned way. Dell did see very strong growth in software, peripherals and in its Asian business with China seeing a jump of +33%. Dell is locked in a global battle with HPQ and they are competing on a price level that prevents them from raising prices to adjust for pricey components. Dell is still opting for more market share instead of more profit. Dell issued inline guidance of 29 cents for the current quarter. Dell had been expected to beat by a penny according to the whisper numbers but the higher memory costs prevented it despite a beat on revenue by +$100 million.

ADI posted better than expected earnings and beating by +4 cents. ADI said profit more than doubled on strong demand for consumer electronics. ADI guided higher for the current quarter as well. ADI makes chips for cell phones and other consumer goods. BEAS took it on the chin after reporting inline revenues but said license revenues failed to hit its targets. BEAS lost -1.50 in late trading. ADIC posted a surprise loss -2 cents and said sales were falling amid rising expenses. Estimates were for a profit of six cents. The stock dropped -25% in late trading.

There was also good news making the rounds with Intel, Dell and others saying they were raising their capex spending as customer demand increased. Dell said corporate demand was at a 3.5 year high. That can't be bad news.

Unfortunately the big brokerages are still cautioning about potential tech weakness ahead. Merrill issued a comment that the odds of a bear market in tech are increasing and hedge funds added to their short positions. In the last hour of trading on Wednesday when the massive short squeeze was in progress there was over $26 billion in volume on the QQQ and SPY. The closer we get to a 200dma failure the more funds are hedging their bets. Currently open interest on the QQQ May-34 puts is 650,000. The May-35 puts are 350,000. These are huge bets the 200-day averages are going to fail.

This bearish sentiment is depressing buyers and the rebound from Wednesday failed to show any follow through. I have heard several stories about why that rebound may have occurred but I think it was purely technical to start and aided by a couple buy programs. On Tuesday I suggested that the 200dma on the SPX at 1078 was very strong support and could produce our best chance of a rebound. We hit 1078 three times on Wednesday with no material penetration. The corresponding 200dma on the S&P futures was 1075.50 and the low for the day was 1075.25. Personally I think we saw a couple strong buy programs on a rebound from technical support on very oversold conditions. The result was a severe short squeeze and a rebound to prior resistance levels.

Had there been any real change in buying sentiment we should have seen some follow through on Thursday. The Dow did recover from the morning PPI dip but could not hold any gains over 10050. It was a battle just to stay over 10K at the close. The current 200ema is 10003 and 200sma is 10017 and the Dow closed right between them at 10010. The index fought those levels for the last two hours of trading and failed to find conviction on either side.

The Nasdaq was also stuck just above its 200ema at 1915 and just below the simple 200 at 1943. It closed flat after trading a dozen points on either side of zero and 1930 seems to be solid resistance. With all the negative bias and the two trips to 1880 earlier in the week we should be thankful just to hold over 1900 for the last three closes. The Dell, BEAS, ADIC, ADI news after the close initially sent the futures into the cellar but they did recover some lost ground while waiting for the Nikkei to open.

On Thursday the Nikkei closed down -328 at 10825. This is nearly -1400 points from the April 26th 12195 high. If the Nikkei falls again tonight the U.S. markets could quickly test their 200dma support once again.

Bonds are continuing to crash on the potential for future rate hikes but it did not hinder the quarterly refunding this week. The 10-yr notes went off at 4.848% with a bid to cover of 2.78. That was the strongest ratio since August-2001. Indirect bidders, a group that included foreign banks, bought 43% of the notes sold. This was very strong and up from 19.9% in the March sale. The 5% level is a level that will attract numerous large buyers and the PPI jump this morning pushed the yield very close to that level. A safe 5% yield can look very attractive to many institutions instead of stocks when the market is shaky.

For Friday we have the CPI, Consumer Price Index, and numbers like we got on the PPI this morning will not be met with much excitement and probably not many buyers. We will also get the Business Inventories, Industrial Production and Michigan Sentiment. None of those are expected to be shockers but just more evidence the economy is growing slowly. If the Nikkei trades down tonight there could be more weekend event risk than usual. The last few Friday's have been mixed with both gains and losses but the last two Friday's have been losers. There is no real trend and this near the 200 day averages we could find about as many bargain hunters as sellers. The wild card is fund flows. With the market hitting new lows this week we could be seeing fund withdrawals and Friday could be a pay the piper day. I could find no reporting of fund flows today and that is normally negative. They want to advertise when money is flowing in but not when money is flowing out. Bottom line, I am still in sell the rally mode and the Dow has strong resistance at 10150 and 10200. Another major dip under 10K may not be bought and the bulls have got to be nervous after barely hanging on to that level for four days. The Nasdaq still has strong resistance at 1930, 1950 and 1965 and very few buyers. Another drop under 1900 could be the signal for the next leg down. Next Friday is option expiration and recently the prior week has seen lots of option related volatility. Tomorrow could be really exciting or really boring depending on who finds conviction first.

Enter Passively, Exit Aggressively.

Jim Brown
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