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Market Wrap

Adrenaline Rush

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      10-21-2004           High     Low     Volume   Adv/Dcl
DJIA     9865.76 - 21.20  9903.15  9800.87 2.04 bln 2164/1050
NASDAQ   1953.62 + 20.70  1957.48  1933.00 2.02 bln 1863/2052
S&P 100   531.26 +  0.54   532.53   527.28   Totals 4027/3102
S&P 500  1106.49 +  2.83  1108.96  1098.47 
W5000   10851.86 + 55.06 10870.68 10775.31
SOX       408.98 + 15.60   411.21   393.36
RUS 2000  576.66 +  6.53   576.70   568.38
DJ TRANS 3431.69 + 45.00  3435.52  3381.86
VIX        14.54 -  0.31    15.19    14.28
VXO (VIX-O)14.99 -  0.11    15.97    14.86
VXN        20.36 -  0.29    20.92    20.21 
Total Volume 4,397M
Total UpVol  3,098M
Total DnVol  1,254M
Total Adv  4545
Total Dcl  2548
52wk Highs  233
52wk Lows   140
TRIN       1.10
NAZTRIN    0.60
PUT/CALL   0.83

Nearly 400 companies reported earnings on Thursday and the results were all over the board. Good news was mixed with bad news and delivered so quickly investors were left dizzy and confused. Strong market moves were made in both directions and outlooks changed faster than traffic lights during rush hour. Welcome to the busiest day in the October earnings schedule.

Wilshire-5000 Chart

Dow Chart

Nasdaq Chart

What a day! I hardly know where to start with mixed economics and even more violently mixed earnings. The Jobless Claims fell -25,000 to pre hurricane levels but analysts suggested it might be too early to get excited. The Columbus Day holiday may have impacted number collection and the low number may be in error. Seems to me there is some qualification on every number we get recently. The headline number was 329,000 for the week and heading for levels that translate to job gains on a consistent basis.

The Chicago Fed National Activity Index fell -0.01 for September and back into negative territory after posting a high of 0.83 back in March. The decline has been very erratic with a spike from -0.08 in June to +.55 in July only to completely retrace that spike in August. Only 37 of the 85 indicators that make up the CFNAI rose during the month. Employment moved to -.09 from -.02 in August and was the biggest contributor to the decline in the headline number. High oil prices were also a factor in the decline.

The Conference Board Leading Indicators fell for the fourth consecutive month with a -0.1% headline number. The Coincident Index also fell -0.2% for the month. These numbers may seem insignificant but the key is the trend and it is clearly down. Declining shipments and narrower yield spreads were two major reasons for the decline along with the pressure from energy prices. This is the only the third time since Jan-2002 that the index has declined more than three months in a row. The outlook is negative for future releases based on the internal trends. The index typically predicts economic trends for the next six months.

Not all economics were negative with the Monthly Mass Layoffs falling slightly to 708 events impacting only 68,792 workers. This was only 51 workers less than the August report but both months were significantly below the recent trends. For instance July had 253,939 layoffs and when compared to Aug/Sept there is a significant improvement. Temporary services accounted for 10% of the Sept number and hit the highest level since 2001. This could be a negative sign that the fringe workers are being trimmed in advance of cutting into the long term workers.

The best news came from the Philly Fed, which exploded to 28.5 compared to estimates for 19.3 and the September number at 13.4. This was clearly a blowout and renewed faith in manufacturing in general despite being only a regional index. Shipments surged to 28.2 from 22.4 and New orders remained strong at 24.6. On the negative side back orders fell into negative territory at -5.4 from last months already weak +3.1. Employment also fell strongly to 14.1 from 21.5. The six-month outlook dropped significantly from 44.9 to 27.6. The report was bullish on the surface definitely showed some cracks in the foundation. These are not insurmountable and as long new orders remain firm the minor weaknesses will be ignored.

That brings us to earnings and this was a monster day with nearly +400 companies reporting. Five Dow components reported with CAT the standout with the best results and the biggest share price loss. CAT earnings more than doubled on strong demand for its products but concerns about high costs knocked -$3.35 of the share price. The basic worry was that continued high oil prices would pressure sales and growth in other countries. Steel prices have doubled and for CAT that is a major expense. Estimates for 2005 saw revenue up +10% compared to +30% gains in 2004.

Dow component Merck reported earnings that fell to 60 cents compared to 82 cents for the same period last year. The Q3 earnings contained a 25 cents charge for the VIOXX recall. However, MRK guided analysts to a higher number for Q4 but many analysts were expecting the charge in the current quarter and not on the Q3 earnings so the real continued earnings should not appear until 2005. Merck said it already had over 300 personal injury lawsuits in progress from the VIOXX claims. MRK was flat for the day at $31.28.

AIG fell another -1.15 on news a grand jury was looking at products that might have been used to make earnings look better. The probe centers on a contract with CELL claiming the company fraudulently concealed losses on the policy. AIG announced earnings that matched analyst estimates and that was the good news. A JPM analyst said he expected Spitzer to extract more than $2 billion in penalties from the current insurance scandal.

Pfizer reported earnings of $3.34 billion for the quarter compared to $2.22 billion for Q3-2003. They beat the street slightly but warned that there would be increased generic competition next year for $5 billion of their products. Considering they will have more than $50B in total revenue next year the minor amount they may lose on generics should more than be made up on Celebrex. The stock appears to have found support at $28.50 and the VIOXX news is slowing.

UPS missed estimates by two cents but used the politically correct hurricane excuse and escaped investor wrath. The company said business was strong and 2005 earnings should grow +13% to +17%. They said the holiday shipping season was shaping up to be a strong season.

After the bell Microsoft beat estimates by +2 cents and said Q4 could be weaker than expected but raised estimates for all of 2005. The company said it was seeing more business decisions on software purchases being postponed by companies from Q4 and into 2005. Unearned income fell unexpectedly and suggests Linux is cutting into their subscription revenue base. MSFT fell -14 cents at the close and about -70 cents in after hours before the call produced some minor buying. MSFT has that monster $32B dividend that will be paid next month and $9 billion of that is expected to be received by retail investors. The rest will be collected by funds and insiders like Bill Gates. The $9 billion is expected to provide a retail bounce for the holiday season and some analysts suggest it could add 25-30 points to the GDP. I assume that was before the nearly $100 billion haircut in the insurance industry.

AMZN dropped -3.46 in after hours after missing estimates by a penny and giving disappointing guidance. The +17 cent earnings were significantly over the +4 cents from Q3-2003 but the bar is pretty high for the online firm. AMZN did say they were well positioned to go into the DVD rental space. The problem came from revenue growth that was less than analysts had hoped. Competition is growing and growth is slowing as the business matures. I bought my first online book from Barnes and Nobel last week because Amazon did not have it. In the past Amazon always had everything and this could be a symptom of the future of their retail model. Skinny the inventory and ignore the slow sellers. With their reputation built as the worlds greatest marketplace it will be interesting to see how this plays out. I might also note I bought 12 other books from Amazon last week so the defection to BN.com for the one they did not have was only a minor detail.

The big news after the bell was Google, which brought back the Internet volatility of yesteryear. When GOOG announced earnings of only 45 cents when analysts were expecting 56 cents the crowd went wild. The stock dropped from $149 to $140 as traders dumped the stock but then rallied back to $162 after they disclosed in the call that there was in fact some hidden charges in the number. The clean number was reported to be 70 cents and a beat. The volatility was huge and analysts could not say enough good things about the stock. However, nobody seemed to want to buy it at the current range. GOOG was touted as having a better growth rate than YHOO, EBAY and AMZN and while that may be true based on today's numbers the field is about to become very crowded. The Google model is not yet fully understood and once understood it will be widely copied. Microsoft is expected to make an announcement soon and Yahoo and Amazon already have products in place and growing. GOOG has a whopping 250 million shares coming eight times the current shares available for trading.

With GOOG adding to the share price each day whether on valid assumptions or not the market cap continues to grow. Eventually this stock will be included in the various major indexes and at the current nearly $50 billion market cap will mean index funds will need to buy large quantities when that happens. This could be months away and after the last lockup release on Feb-15th of 176 million shares. Currently there are slightly more than 30 million shares in circulation and another 40 mil will be released on Nov-16th a little more than three weeks from now. Additional releases of 25M each will occur on Dec-15th and Jan-15th.

The bad news came from numerous chip stock earnings. There were several today including BRCM, HLIT, IDTI, KLAC, MCHP, TQNT and XLNX to name a few. Led by BRCM several warned about Q4 and the amount of orders being pushed into 2005. BRCM warned that sales could drop as much as -18% in Q4 on delayed customer orders. They blamed excessive chip inventories still held by their customers due to weak Q3 demand. They said weaker sales of networking and satellite equipment had rippled back to them through the supply chain.

XLNX warned that revenue would be down for the quarter based on increasing inventory levels at customers. The average inventory level at quarter end was 156 days, up from 131 days in the prior quarter. KLAC also said they saw a decline in Q3 and another decline is expected for Q4. They said sales to foundries had slowed significantly. TQNT warned that they would have a bigger loss than they previously expected for Q4, sales were slowing and their book to bill had dropped to only 0.81. MCHP warned that despite record sales in Q3 their expectations for Q4 had fallen. IDTI repeated the claims that Q4 would also be a challenge as customers wade through excess inventory. Sounds like they have the excuse committed to memory.

That pretty well makes it unanimous that chip inventory has not improved and is not expected to improve for Q4. Based on dozens of company forecasts this situation is expected to pass by Q1-2005. The warnings tonight were nothing new and exactly like the warnings we have seen from chip companies for the last two months. Despite those warnings the SOX rose to a three week high today and the SMH did not lose any ground in after hours trading. The bad news appears to be fully priced in and traders are buying chips six months ahead of when they believe the next demand bounce will occur. Those buying today are looking at the April earnings as an exit point if the current tech scenario completes as expected.

SOX chart

Today was the largest earnings schedule for the Q3 cycle with nearly 400 companies reporting. As of yesterday's close 223 S&P companies had reported with an average increase in revenue of +9.2% and an average earnings increase of +10.8%. Analysts expect the final total to show earnings growth of +14.8% but as you can see by the current total there is a big gap. The breakdown of the results so far is shown in the following table and it is still not that bad.

2004-Q4 Comparisons

Partial list of companies reporting after the close:

KO  earnings est +0.47, actual = +0.50 
ACF earnings est +0.39, actual = +0.43 
ACS earnings est +0.71, actual = +0.72
CLS earnings est +0.08, actual = +0.11 
ELX earnings est +0.10, actual = +0.11 
GNW earnings est +0.54, actual = +0.55
MCK earnings est +0.24, actual = +0.29
RHI earnings est +0.21, actual = +0.24
SFA earnings est +0.36, actual = +0.36 
AMZN earnings est +0.18, actual = +0.17
BRCM earnings est +0.34, actual = +0.36
CAMD earnings est +0.09, actual = +0.10 
CPKI earnings est +0.25, actual = +0.27 
EPNY earnings est -0.07, actual = -0.06 
FDRY earnings est +0.12, actual = +0.11
GILD earnings est +0.21, actual = +0.25 
GOOG earnings est +0.56, actual = +0.70 
HLIT earnings est -0.03, actual = -0.03 
NSIT earnings est +0.29, actual = +0.30 
IDTI earnings est +0.07, actual = +0.09 
KLAC earnings est +0.57, actual = +0.58 
MENT earnings est +0.07, actual = +0.05
MCRL earnings est +0.07, actual = +0.08
MCHP earnings est +0.29, actual = +0.29 
MSFT earnings est +0.30, actual = +0.32
OSTK earnings est -0.20, actual = -0.16
PSFT earnings est +0.14, actual = +0.17
PLCM earnings est +0.19, actual = +0.19 
RSAS earnings est +0.14, actual = +0.15 
SIAL earnings est +0.81, actual = +0.81 
TQNT earnings est -0.04, actual = -0.03 
WEBX earnings est +0.24, actual = +0.26
XLNX earnings est +0.24, actual = +0.24
YELL earnings est +1.34, actual = +1.38

The obvious question is where do we go from here. The overall earnings are not that bad although expectations from techs for the next quarter are falling. The SOX is telling us the bad news is priced in despite the pummeling the Dow has taken over the last several sessions.

However, was it really that bad? The Dow is only composed of 30 stocks and there have been some monumental blowups over the last several weeks. Drugs and insurance aside the weakness we have seen has been due mostly to the huge impact of individual stocks on the Dow. Using the broader indexes of the Wilshire-5000 and the Russell the markets are not in that bad of shape. The Wilshire is comfortably holding the high ground above 10800 support and only -300 points from a new high for the year. The Russell is also holding the high ground over 560 support and only 25 points from the breakout 600 level. This is not bad news despite what the Dow appears to be showing.

The Dow has tested 9800 for two consecutive days and saw nearly a +100 point rebound on both days. Neither stuck due to individual stock issues. Today it was CAT and its -3.35 drop taking nearly -30 points off the Dow along with the continued AIG weakness. They were the only two Dow components losing more than $1 for the day. Dow 9800 is the conversational low of the year from August with the actual low 9783 but close enough for most. This 9800 retest is exactly where an October bottom should occur if it is in the cards. A break of the 9800 level would change all the rules but I will wait to cover that if it happens. Bulls really want to see the Dow rebound from this level and tomorrow would be nice. There are no economic reports to confuse the issue.

The Nasdaq has actually been rising since the Oct-15th lows at 1900. The close today at 1952 is just one good day away from a potential breakout over 1975. It appears the October low was already made and the bad news bulls are back. This will of course be tested again tomorrow after the multiple chip warnings tonight.

The futures are well off their lows and nearly positive as I type this and they appear to be indicating another bounce at the open. With the election only seven trading days away and October almost over there is a rising bid beginning to appear. Unfortunately every bounce is sold so there is still major resistance to be overcome. Any fund portfolio shuffling for their October year end should be over and if anything they should have cash to spend. TrimTabs reported tonight that fund flows for the week were positive to the tune of +$1.5B on top of +$1.4B last week. The tide may be turning and hopefully the worst is behind us.

For Friday I think traders will be watching oil and chips and nothing else. Oil closed at $54.50 again and is higher overnight. Like the chip warnings I think investors have decided to ignore oil and consider it a "transitory event" using the Greenspan terminology. That sets up Friday as a possibly bullish day assuming chips don't suddenly implode. Watch the Wilshire, Russell and SOX for the real market direction.

Enter Passively, Exit Aggressively.

Jim Brown


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