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Market Wrap

Nonetheless

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      07-01-2004           High     Low     Volume   Adv/Dcl
DJIA    10334.16 -101.30 10448.09 10274.51 1.78 bln 1380/1850
NASDAQ   2015.55 - 32.20  2045.53  2006.67 1.77 bln  938/2124
S&P 100   549.01 -  4.86   554.43   545.85   Totals 2318/3974
S&P 500  1128.94 - 11.90  1140.84  1123.06 
W5000   11024.15 -114.80 11140.79 10975.26
SOX       467.03 - 18.10   485.09   462.59
RUS 2000  582.43 -  9.09   591.52   582.43
DJ TRANS 3172.01 - 32.39  3212.45  3160.17
VIX        15.20 +  0.86    15.57    14.41
VXO (VIX-O)15.08 +  1.09    15.99    14.40
VXN        20.06 +  0.69    20.68    19.59 
Total Volume 3,883M
Total UpVol    726M	
Total DnVol  3,112M
Total Adv  2686
Total Dcl  4466
52wk Highs  261
52wk Lows    86
TRIN       2.75
NAZTRIN    1.91
PUT/CALL   0.93

The key word in the Fed announcement was "nonetheless" and not "measured pace" and that difference was felt in the market action on Thursday. Post Fed trading was less than inspiring as a new flurry of earnings warnings produced a cloud over the markets. Adding to that cloud was a weaker than expected ISM and stronger than expected Jobless Claims. Cracks were forming in the bullish sentiment on multiple fronts.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

SOX Chart - Daily

The morning began badly with stronger than expected Jobless Claims which came in at 351,000 with last weeks numbers revised up to 350,000. This makes three of the last four weeks at 350,000 or higher and suggests the employment picture is not as strong as economists would like. The four week moving average rose to 347,000 and the highest level since April 17th. With the June employment data due out tomorrow the markets were not excited about the 350K level being breached so frequently.

Offsetting the Jobless Claims was a stronger report from the Monster.com Employment Index which rose to 136 in June from 128 in May. This was a +6.3% increase and the jobs were spread across most geographic sectors. Management and Administration positions were the strongest with the Sales and Production components barely budging. This data is not adjusted for seasonality as are all the other employment surveys and it is difficult to determine if it was a seasonal bounce or a real change in hiring. This index represents the change in jobs advertised and not jobs filled.

The key report for the day was the ISM for June and at 61.1 it still represents an expanding economy but it was the lowest level seen since last October's 57.0. The high of 63.6 was posted in January and the number has been moving lower since. There was a small bounce to 62.8 in May but June's -1.7 drop erased all the gains. The problem for June was in the New Orders and Backlog components. New Orders dropped from 62.8 to 60, down from the 73.1 high in December. Order Backlog fell to 58.5 from 63.0 in June and the 66.5 high in April. New Export Orders fell nearly -4 points from 60.6 to 56.7. Employment fell from 61.9 to 59.7. Good news came from a drop in Prices Paid from 86.0 to 81.0 but bad news came from a nearly +2 point jump in inventory levels to 51.1.

The conclusions drawn from the ISM are not very exciting. Orders are down, inventory is up with employment dropping again. This appears to be confirmation of the many smaller reports from earlier in the month suggesting the economy is cooling. What this means in English is we are no longer expanding at a red hot pace but more of a lukewarm crawl. The lack of any inflation in the prices could be due to the continued slack in the economy and the inventory buildup. This is good news for the Fed but troubling news for traders. With the market priced to perfection a slowing of growth at the same time the Fed is raising rates is a recipe for disaster.

It might sound like the ISM was all negative and that is far from the truth. The ISM has now been over 60 for eight months and that is the first time in over 20 years. The economy is still expanding only that pace of expansion has slowed over the last four months. The odds are good that string will be broken next month.

The problem for the markets today came from multiple fronts. The Fed statement was one area of concern. While everyone expected the Fed to raise rates again before year end they would prefer that it occur in an orderly measured pace. The Fed added the clause "Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability." While the "measured pace" term was still used in the preceding sentence the "nonetheless" qualification removed it from consideration. The Fed tried to ride the fence and ended up with splinters. They tried to appease the markets but just had to have the last word. That last word worried the markets that there is still a danger of a repeat of the 1994 runaway rate hikes. If the economy was still expanding at a faster rate this statement may not have been a real problem. The ISM confirmation of weakness in prior reports that the expansion is slowing only served to highlight the phrase.

Another challenge for the markets was some window undressing before the holiday weekend. Those who bought stocks last week in anticipation of a Fed celebration rally were quick to bail out when that rally did not occur. Remember all the talking heads that predicted a market relief rally if the Fed would just go ahead and raise rates and remove the uncertainty? They were conspicuously absent today as the market imploded.

Also impacting the averages was another flurry of earnings warnings and lowered guidance. Many tech companies confessed to lower earnings prospects and the Nasdaq took it on the chin with a -32 point drop. Leading the big cap indexes down was very disappointing auto sales and further evidence of the slowing economy in general. GM reported sales fell -15% and much more than anticipated from their warning last month. Ford said sales fell -8%. Both companies said they were working to increase sales. Translated that means the incentives offered in the showroom was going up once again. The average incentive today is just over $4000 with some vehicles well over $5000. The problem with autos is the lack of demand. They have been giving them away for three years now with zero percent and buy one, get one gimmicks and there is no pent up demand. Used car prices have fallen off the planet and junkyards are crushing newer cars than ever before and on a regular basis. We have discussed the lack of future car buyers for the last two years as each round of incentive increases was implemented. Short of putting car keys in Wheaties boxes the car companies are going to have a tough time moving inventory for the next several months. The new model year will be their best hope.

Cardinal Health was the biggest loser of the day and lost -$7 billion in market cap and -$17 off their stock price when they issued a high profile earnings warning. Three funds collectively lost over $1 billion on the news. The Fidelity Dividend Growth Fund and Fidelity Advisor Dividend Growth along with the Vangard Health Care Fund lost big bucks. CAH was a top holding in each. CAH was also 1.3% of the Fidelity Magellan Fund with assets of $67 billion. Tough to wake up to that kind of haircut as a fund manager. All your work for the last six months wiped out in one day by one stock.

Other earnings warnings for the day included COLT, WMAR, PSTA, ELX, ESPD, CCUR, AMKR, MERX and SIPX to name a few. The index with the biggest loss was the SOX after Smith Barney downgraded the sector and AMKR warned of sector problems. AMKR cut its estimates to +6 cents from 17-22 cents analysts had expected. They cited weakness in cell phones and shortages of semi components. Morgan Stanley also tanked the sector saying Intel guidance, due out with earnings on the 13th, could be below analysts expectations. Add in the ELX warning of slow sales and the SOX dropped -18 (-3.72%) for the day. Needless to say the Nasdaq did not have a chance.

The Nasdaq gave back -32 points of its gains for the week but managed to close right on the bottom of its current range at 2015. The Nasdaq rallied out of its prior range (1965-2000) on the 23rd and has refused to go back. The drop today was over by 11:30 but no rebound appeared. The Nasdaq closed off its lows but only barely. The key here is still the SOX and with nearly a -4% drop there is no way the Nasdaq could have produced a gain. The SOX fell back below the 470 support level, which had held all week and clung to 465, the last stop before testing 450 again. If the Intel rumor picks up speed we could easily test 450 again next week. I kept thinking all day we would see some chip buying at the close but it never appeared.

The Dow took a serious header off the high board and landed face first several points below the bottom of its recent range. The Dow traded down to 10274 and under the 10300 level which has held for nearly four weeks. We did see a recovery at the close back to the prior 10330 resistance level but the rebound ran out of steam.

As with every long holiday in recent memory the rumors of terror threats/events were flying. It was so bad at one point that the Homeland Security Dept had to make a statement that they were not raising the threat level and there were no credible threats for the coming weekend. That is almost more scary than a credible threat because it means there is no concentration of force to prevent the event. It is almost as though the cops are going on holiday as well because there is no visible enemy. There were also several commentators suggesting the Democratic Convention was the most likely target for a regime change attack because the attacked party tends to get the most sympathy. With the goal to sink Bush the commentators thought the Boston convention was not only the easiest target in population density but the preferred target as well. You can bet the security will be extreme and it will not be an easy target by the time the convention begins.

In the end it was not the rumors that tanked the market but the perception that the Fed was ready to aggressively raise rates just as the economy appeared to slowing even further. It fell on worries that earnings were going to disappoint and on several key downgrades. Yahoo for instance was knocked for a -2 loss on a change in search strategy by Microsoft. Valuation downgrades are beginning to become common place and earnings warnings only accelerate the worry.

Still the most likely fear factor impacting the markets today was the Employment Report tomorrow. The current consensus estimate is still +275,000 jobs and traders were beginning to fear a disappointment. We have seen employment drop in almost every report except for the Monster Index. We have seen Jobless Claims rise back to the 350,000 level for three of the last four weeks with the four week average at 347K. These are not positive signs for the Nonfarm Payrolls. I have heard several whisper numbers this afternoon in the 100-110K range. While this would still be a positive gain it would be a sentiment loss. The perception that employment is accelerating would be dashed and cast more suspicion on the strength of the recovery. A major drop in new jobs would weaken the republican stance and give Kerry more ammunition. The race is already a tossup and that could give investors more election indigestion. Should we see a minus sign in front of the number it could be lights out for any July rally.

July is typically the best month of the third quarter and we certainly did not get started off on the right foot. The Dow lost -101 points and broke crucial support intraday. The S&P also traded below 1125 support and managed almost no rebound. Oil spiked back over $39 on comments from Saudi Arabia that they thought it was fairly valued in the upper $30s. What happened to the $25-$30 target price we have been using? Inflation in its purest form brought on by supply and demand. The jump in oil and rates and the drop in orders and jobs knocked the hope out of the market and the result was an ugly day.

Normally the trend into the July-4th holiday is up with an earnings led rally for the following week. Not looking too good for that rebound tonight. For the market to have any hope of repeating that trend the Nonfarm Payrolls had better be strongly positive and at least 100K or more. With the implied weekend terrorist threat a wimpy number is not going to instill confidence and create an urge to buy.

There is good news in the market but it was hidden by the various factors above. Real rates fell to nearly a two month low despite the Fed rate hike. The yield on the ten-year closed at 4.564. The market had priced in the potential for a 50 point hike as well as strong economics. We got neither and bonds continued to climb. This will help home sales and take some of the fear of the Fed out of the market. This fact will surface next week and you can count on it. We will also need some positive earnings news in order to capitalize on the rate drop and that could be a challenge.

For Friday I would look for a good Jobs number to start some bargain hunting ahead of the earnings parade that begins next week. However, don't just jump in assuming we will go higher. We did break support intraday on Thursday and that could be a signal of things to come. The market will confound the most people possible and summer trading is very tough. Wait for a real trend to appear.

We are also playing in some fast traffic. The NYSE reported that program trading was responsible for 70.5% of all trades on the NYSE for the week ended June 25th. 70.5%!!! This is an all time record and something that should indicate to us all how little retail trading is actually being done. According to the NYSE an average of 1.119B shares were traded each day. Since there was only an average of 1.588B shares traded each day this means less than 470 MILLION shares of retail trading per day. This is a picture of the summer doldrums at its best. Here is the link to the NYSE report:

In the for-what-its-worth category Abby Joseph Cohen gave her carefully scripted market outlook on Wednesday. She said the markets were 12-15% undervalued and we could see a significant rally by year end. Using the S&P as of Wednesday that +12-15% gain would put the S&P at 1275-1311. Definitely a far cry from our 1025 support today. She also said the rally might not occur until late November or December due to the election. I hope she is right but I would not mortgage the kids to bet on it. Interesting that she chose to make her appearance during the post Fed bounce where all the pundits were predicting a celebration rally.

Enter Passively, Exit Aggressively.

Jim Brown
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