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Market Wrap

Thank You Elliott Spitzer

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      10-14-2004           High     Low     Volume   Adv/Dcl
DJIA     9894.45 -107.90 10003.36  9875.13 1.66 bln 1285/1805
NASDAQ   1903.02 - 17.50  1921.82  1900.77 1.47 bln  973/2052
S&P 100   529.58 -  5.90   535.73   528.75   Totals 2258/3857
S&P 500  1103.29 - 10.36  1114.97  1102.06 
W5000   10788.48 - 92.52 10892.34 10777.97
SOX       380.60 - 12.70   393.25   378.98
RUS 2000  564.88 -  4.54   570.06   564.79
DJ TRANS 3302.90 + 20.50  3315.18  3282.57
VIX        16.43 +  1.01    16.56    15.22
VXO (VIX-O)17.13 +  0.88    17.80    15.78
VXN        22.30 +  0.17    22.67    22.03 
Total Volume 3,424M
Total UpVol  1,038M
Total DnVol  2,339M
Total Adv  2556
Total Dcl  4333
52wk Highs  102
52wk Lows   139
TRIN       1.58
NAZTRIN    1.00
PUT/CALL   1.07

Single-handedly Elliott Spitzer turned into a one man wrecking crew and sent the indexes into a death spiral at 10:30 this morning. Spitzer took aim at the major insurance companies in what he called a major scandal and financial stocks imploded. Dow component AIG lost -7 points taking nearly -63 points off the Dow.

Dow Chart

Nasdaq Chart

SPX Chart

Wilshire-5000 Chart

Spitzer said he was going to sue Marsh McLennan for a wide ranging scheme to defraud clients and sell insurance at artificially high rates. The four major insurers took substantial hits with AIG -6.99, AOC -4.48, CB -4.09 and MMC a whopping -11.28. In what could develop into a RICO prosecution Spitzer has taken aim at these monster companies and claims their pattern of business practices are fraudulent. The case stems from the quotation process. According to Spitzer companies like MMC accepted payments from insurers to sell their insurance at higher prices than the competition. MMC supposedly would produce fictitious quotes putting the company they wanted to win in the quote at the price they wanted to get for the insurance.

The challenge was the relationship between the client and broker created fiduciary responsibility and MMC and others violated that responsibility by taking payoffs for quote positioning. They were representing the quotes as the best available when they knew there was insurance available at cheaper rates in their own rate book. MMC reportedly made $800 million in kickbacks last year and that was nearly half of their total profit.

When asked in a TV interview if he was going to put the companies out of business he ducked the question but stated the companies were not cooperating. Because these companies deal in various securities as well a felony conviction could put them out of business like Arthur Anderson. It is a death sentence for financial entities and based on Spitzer's description of the complaint it could happen. However, because these four companies represent the majority of business written in the U.S. the odds are good there will be a settlement with those that cooperate. One could be made an example and sent down the tubes as a warning to the rest. MMC appears to be the target of choice.

MMC Chart

Before the insurance bomb hit the markets they were already struggling under a widening oil slick and having trouble just treading water. A fire at a west coast refinery did not hamper production but prices continued to climb. Oil inventories rose +4.2MB for the week and much more than expected but prices still rose. Heating oil inventories fell sharply and prices hit another all time high with a close at $1.548.

Crude Chart

Heating Oil Chart

While the market was being ransacked by the insurance and oil problems the semiconductor sector was also under attack. The list of chip stocks either missing earnings or warning in the last 48 hours was long and it was still getting longer at today's close. The list included NVLS, FLEX, SNDK, LRCX and PHTN to name a few. The SOX lost -12 points or -3.21% but the damage could have been a lot worse. The SOX found support at 380 and clung to that level all afternoon. This limited the Nasdaq loss to only -17 points and kept it from breaking 1900 support. The 380 support could be critical to our market direction on Friday. A break of that level could see a return to the lows for the year at 350.

SOX Chart

Economically the news was not good either. The Jobless Claims rose to 352,000 and the four-week moving average rose to 353,000. This is not good news for the recovering economy. There were no hurricanes to blame and California and Illinois were the states with the biggest increases. Claims under 150K equate with job gains in the employment report over 100K per month and claims over 150K generally equate to a flat to down job market.

Import prices rose a smaller than expected +0.2% but odds are good next month will show a dramatic increase. Oil prices have rocketed higher and this should skew the numbers dramatically. The International Trade numbers reflected a much stronger impact of oil prices with the trade balance slipping to -$54 billion and the second highest level in history. Import growth is soaring at +20.7% and at record highs while export growth is rising at a slower +14.2% rate. At the current rate foreign trade will subtract from our Q3/Q4 GDP instead of contribute to its rise as in Q1/Q2.

Friday has some critical economic reports and the market will be looking for some relief. The NY Manufacturing Survey is expected to be weaker after a strong rebound last month. How weak will be the key. We will get the PPI for September and the consensus is for a flat reading but eventually oil prices have to produce a strong bounce in the PPI numbers. Retail sales are expected to show a bounce to +0.6% for September on back to school shopping but the cycle was noticeably weak in most areas. Consumer Sentiment is expected to be flat at 94.9 but with the election mudslinging and rocketing energy prices there is the potential for a major drop. Business Inventories are expected to rise +0.7% but if the economy is really slowing as much of the earnings guidance has indicated those inventories could be much higher. Friday could be rocky economically.

Even without the insurance bomb the Dow was already in trouble with the warning from GM. GM said it was cutting 12,000 jobs in Europe and would be cutting more in the U.S. They slashed profit forecasts and said demand remained weak. They may have reached a point where they can't provide enough incentives to sell more cars. With up to $6,000 in incentives on some models the company has tried to keep production rolling but now may be forced to close some assembly lines. Merrill Lynch said they are likely to close at least one plant completely and possibly more. The high incentives helped dealers liquidate 230,000 units of their current 1.137 million units of unsold cars and trucks in Q3. With strong tax bills ahead in December for dealers stuck with those vehicles at year end we can expect huge promotions to move inventory over the next two months.

The Dow retreated to close under 9900 and at the May lows. This is a very important support level and we are closing in on the August lows at 9783. This is the make or break time for the Dow. A successful test of 9800 would create a double bottom and a potential launch point for a post election rally. A failure at 9800 would be very critical and could easily project to 9600 to 9300 depending on which technical analyst you believe. A break below 9800 would be a lower low and break many of the technical models suggesting an end of October rally.

The Nasdaq is much stronger than the Dow and clung to support at 1900 most of the afternoon. This is decent support and considering the rash of earnings misses and warnings in the tech sector it is amazing we held this level. A break here targets 1850-1860.

I am clinging to my bias that we should see a rebound over the next couple of days. Technically speaking we should plummet to new lows and not look back. However, the last two weeks of October in election years are almost always bullish if the incumbent is ahead. The problem we are facing is an election with no leader, oil prices soaring despite higher inventory levels, terrible earnings and a very high ratio of negative guidance. We are also facing the start of Ramadan, the Muslim holy month, on Friday in Saudi Arabia. During the month Muslims are forbidden to eat, drink or smoke during daylight hours. Also during Ramadan we have historically seen an escalation of terrorist activities.

This makes tomorrow even more volatile than normal for an option expiration day. Four of the economic reports for Friday will be released before the open and fortunately for us there are no major earnings. Earnings after the close today failed to dent the overnight futures despite some spectacular failures. Juniper beat the street and raised guidance but got killed for more than a -$2 drop in after hours on comments about a recent acquisition. Juniper has beaten estimates for eight straight quarters. CNET beat the street but warned for Q4 and lost -12% in after hours trading. LEXR posted inline and traded down. RMBS beat the street and traded level. SUNW beat the street but traded level on a weak outlook. CREE beat the street by +4 cents but lost -1.50 in after hours after guiding revenue lower and earnings higher. The highest profile failure was NFLX. NFLX beat estimates by +3 cents but then traded down to $11 from $17 after saying they expected competition to become increasing stronger and they were slashing subscriber rates to combat the trend. Blockbuster has a competing service now and Amazon is expected to enter the competition. That -37% drop in the stock was on heavy volume.

That makes a very light earnings schedule on Friday good news for the bulls because even good earnings news has been riddled with negative factors. This could be a critical day for the bulls and they had better rally the troops to stave off a break of 9800. While we are running out of reasons to move higher the expectations for the end of the year rally remains the same from most analysts. The divergence between economic reality and market expectations is growing about as wide as the reality gap between oil prices at all time highs and the Transports soaring like diesel was 29 cents a gallon. Eventually all divergences return to reality and while I was expecting it to happen in January for equities there is always the possibility that market conditions for creating the perfect storm are currently forming. If you are bullish Monday should be the day to go long with historical trends in your favor. It also means that Friday could be highly volatile as everyone positions for the expected move.

Enter Passively, Exit Aggressively.

Jim Brown


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