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Market Wrap

Earnings Deadlock

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      07-13-2004           High     Low     Volume   Adv/Dcl
DJIA    10247.59 +  9.40 10257.10 10230.63 1.49 bln 1596/1635
NASDAQ   1931.66 -  5.30  1945.17  1930.59 1.52 bln 1454/1588
S&P 100   544.00 +  0.30   544.84   543.03   Totals 3050/3223
S&P 500  1115.14 +  0.79  1116.30  1112.99 
W5000   10854.69 +  5.67 10869.10 10837.81
SOX       449.42 -  0.80   445.35   436.61
RUS 2000  562.69 +  0.45   564.93   562.24
DJ TRANS 3079.74 - 11.90  3092.07  3079.43
VIX        14.46 -  0.50    16.20    14.28
VXO (VIX-O)15.68 -  0.39    16.20    15.33
VXN        21.42 -  0.31    21.80    20.62 
Total Volume 3,233M
Total UpVol  1,396M	
Total DnVol  1,730M
Total Adv  3461
Total Dcl  3668
52wk Highs   93
52wk Lows   160
TRIN       0.96
NAZTRIN    2.04
PUT/CALL   0.79

Traders fought to a deadlock today as they waited for Intel earnings after the close. All the major indexes added together were still within a dozen points of the flat line with the SPX, OEX, SOX, RUT all failing to gain/lose a full point. It was definitely a day spent waiting instead of trading.

Dow Chart - Daily

Nasdaq Chart - Daily

The day did not start off well with Chain Store Sales flat with the prior week. Year over year growth fell to only +3.4% and the lowest level since last August. We are now entering some tough comparisons from 2003 and we do not have a tax rebate cycle this year to pour extra cash into the system. This coupled with the high gas prices are likely to keep pressure on retailers into the holidays.

Further bad news came from the Richmond Fed Manufacturing Survey which fell to 14 from 22. New Orders fell to 1 from 12 and Order Backlog fell to -12 from -1. This was a very negative report and while the headline number was still positive it showed a significant slowing in manufacturing activity in the Richmond area. All components showed declines except in future employment. Confusing analysts was a drop in current employment of -8 points to only one, but the index of expected employment jumped +7 to nine. Orders down, shipments down, backlogs down but future employment expectations spiking to the upside. This definitely confused investors. The report was the exact opposite of the Kansas City Fed Survey reported on Monday where the headline number jumped to 51 from 35. This continuing contradiction in the economic numbers is keeping traders off balance as well as analysts.

The big news for the day was not economic. The markets wandered aimlessly in a narrow range while waiting for Intel to announce earnings after the close. Intel did announce inline earnings but that was the only thing in line. They missed slightly on revenues and lowered their gross margin estimates to 60% from 62% with margins for Q2 falling to 59.4%. The margin decline is critical for Intel as this is the yardstick analysts use to gauge its performance. With revenue in the $8 billion per qtr range it is easy to see a huge move in revenue with no corresponding move in earnings. Intel give their margin estimates so analysts can make assumptions on earnings based on the various revenue projections. Essentially it gives them the yardstick to measure the quarter.

With gross margins falling and revenue a little light it suggests times are getting slightly leaner for Intel. They said the drop in margins was due to a product mix shifting to lower priced, lower margin items. High dollar processors were said to be soft and this means corporate sales are not growing. Sure the gamers and graphic artists are buying the hottest processors available but the standard retail PC for mom/pop, home and school is turning into the run of the mill setup that can compete with other sticker price on dealers shelves. With 2.4ghz Pentium4 systems selling for $399 on the Internet it is not tough to see why Intel margins are shrinking.

Another challenge was a jump in inventory for Q2 by +15.3% after a +11% jump in Q1. Intel is building products that are not jumping off the shelves and that brings up concerns of slowing consumer trends from yet another angle. Any way you look at it an increase in inventory of more than 25% since January means sales are not occurring as planned. This coupled with the lowered margins is what pushed INTC down -1.36 in after hours. Andy Bryant said in an interview they were seeing some pricing pressures in processors and it would take them 1-2 quarters to work off the extra inventory. On the bright side he said they were seeing normal seasonal trends and he expects business to continue to grow. Personally I think Intel is a great company and they will continue to post increasing earnings but there may be a buying opportunity ahead. I remember several times in the past where Intel got ahead of itself and inventory built to levels where it had to write down massive amounts of obsolete chips. Obsolete to Intel can be a very short period due to their rapid development cycle. "Old" processor chips today may be 6-9 months old with multiple newer chips in production and others in the pipeline. Intel does not wait until they are scrap to write them off. They aggressively manage inventory and write off unsold chips quickly while they still have life at some price. I believe this is coming and could show as soon as Q3.

Intel could begin an aggressive price cut strategy to dump the chips and that will again lower their margins. This will initially pressure the stock price. Intel is trading at $24.90 in after hours and under $25 is below prior support at $26. I suspect we will see an attempt to trade $24 and that is the last real support level before $20. I think it is a buy at $24 for long term investors but it is a REAL bargain at $20. I would jump on INTC leaps at any price between $20-$24 and average cost into a multi contract position. The next three months may be dead money but then long term is the key here.

Juniper also announced earnings after the bell and beat analysts estimates by a mile. Juniper posted +8 cents compared to estimates of +4 cents and raised guidance for the future. Juniper was up +2.02 in after hours at $24.21 and well over the $21.99 close. They also announced a buyback of $250 million in stock. This is the way earnings are supposed to work.

Going the other direction was Merrill Lynch which posted earnings that rose +10% but fell short of expectations. Merrill missed estimates due to weak trading results but showed gains in management fees and mutual fund commissions. Merrill said the firm lowered its risk profile from trading in Q2 after low market volume and low volatility made it more risky to trade. Welcome to the club! Merrill said on their call "it was a difficult trading month (June) and we made a conscious decision to reduce trading." With a $1 billion profit for the quarter the decision to reduce risk was probably a good call. They also announced another stock buyback of $2 bil. MER sank to a 52-week low and closed at 49.80. Next support is $45 and then $40 but I would be very surprised to see much more of a drop. A stock that is making $1+ billion per quarter and buying back $2 billion in stock, its second buyback of this size this year, will find buyers pretty quickly. This is another stock that should be in everybody's portfolio once the election is history.

Red Hat turned into a dunce cap today after they said they would have to restate financial results for the last three years. RHAT said they do not expect a "material" effect on annual revenue or cash flow but traders immediately took the stock to the woodshed for a -22% whipping. RHAT dropped -$4.62 to close at $15.72. Red Hat was booking a full month of revenue for any monthly subscription started during the month. Under the new revision they will book revenue on a daily basis depending on when the subscription began. They estimate less than 3% of their revenue will be impacted by the change. The portion of the month that was not actually earned although collected will be deferred until the end of the contract. It does not go away it just gets deferred. The problem is not in the restatement but in confidence in the company. The companies outlook has not changed and with a record number of corporations finally looking at moving from the Microsoft dominated operating system market to a significantly cheaper alternative the future is bright.

This must be my day for bargains because I view all the stocks above, INTC, MER, JNPR and RHAT as long term holds in any portfolio. The buying opportunities in three of them are gifts to traders looking to buy stocks on the cheap. The real problem here is looming in our future and it is not stock related. It is event related and we have a full calendar ahead. We have the Democratic convention on July 26th, Olympics Aug 13th to 29th, Republican convention on August 30th and finally the election in November. In the middle of that stretch there are the two weakest months of the year in Sept/Oct. The potential for a terrorist attack at one of those events may not be as high as in the past but the potential for thousands of news articles discussing the risk is about 100%. While I would want to recommend to investors to buy those four stocks on weakness today there is always the potential for another dip ahead.

These fear factors are keeping investors on the sidelines with no urgency to buy. Volume has dried up faster than summer rain in Arizona. Volatility does not exist and we continue to be range bound but we could see a break in that range any day now. The Dow has been stuck in a range under 10250 since July 6th and that is exactly where we closed today. The market was primed and waiting for an Intel earnings win to send us higher. Futures are down about -4 points in overnight trading and it appears we will open down tomorrow. Our support is 10175 and the 200dma so the minor Intel problem may not attract enough selling interest to break us out of the range but just send us back to the bottom.

SOX Chart - Daily

The Semiconductor Index is right on the verge of a major crash. It has found support in the 440 range since May and we have tested it several times. The Intel news sent the vast majority of chip stocks down in after hours and this suggests the SOX will break this 440 support at the open. This is not good news for the Nasdaq or the Russell.

The Nasdaq has more risk with a close today at 1931. The Nasdaq has initial risk to 1900 but the Juniper win could help offset the Intel weakness. The current Nasdaq pattern has moved from range bound to more of a decline but that could have been in anticipation of the Intel report. How the Nasdaq and the SOX react tomorrow to the Intel guidance will be a key but not the answer to the next few weeks of trading. The next major impact to the market could come from IBM on Thursday. If IBM does not trip then tech investors may start focusing on the positive comments from the blue chip giants and the bargain hunting could begin.

I just expect that bargain hunting to be muted for the next month regardless of the earnings news. Even if everybody began beating estimates I doubt we would see a breakout move before Labor day. That keeps me thinking there is the potential for a low volume slide ahead and a better buying opportunity for all those stocks I listed above. Patient money is safe money and I plan on being very patient over the next six weeks.

Enter Passively, Exit Aggressively.

Jim Brown
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