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MARKET > Commentary Sunday, March 18, 2001
by: S.P. Brown

One For The Ages

The South Sea Company and the Mississippi Company have nothing on today's technology sector. For those folks short on history, the South Sea and Mississippi companies were two enterprises concocted in the early 18th century to exploit the vast riches of the New World. What was exploited, though, were greedy, na´ve investors, who bid up the shares of both companies to Rambus-esque levels.

Well, no sense in making a short story long (I'm sure you can see where I'm headed with this, anyway), the inflated shares in both companies soon burst like so many distended bubbles and millions of dollars of shareholder value vanished in a mere instance.

Now compare the South Sea and Mississippi bubbles with today's latest bubble, and there really is no comparison, at least when it comes to scope and forfeiture of wealth, because this latest bubble-burst has soaked investors for trillions of dollars ($4.8 trillion to be exact), not mere millions. What's more, the South Sea and Mississippi bubbles were, for the most part, limited to London and Paris, whereas today's technology bubble is limited to the planet.

There is one notable similarity, though, and that's the presence of unctuous hucksters promoting the merits of investing in companies with no earnings trading at a few hundred times negligible sales. South Sea had Robert Harley and Mississippi had John Law while high-tech had Mary Meeker and Joe Battipaglia.

But this is not to imply that investors are blameless; they certainly are not, but at least they should be forgiven their transgression because as Albert Einstein once said, "There are only two truly infinite things, the universe and stupidity. And I am unsure about the universe."

With that said, the latest round of investor misgivings resulted in another bubble bursting to the tune of $900 billion this week. This time, however, the selling wasn't limited to the formerly high-flying Nasdaq tech issues. On Friday, the Dow Jones Industrial Average (INDU) plunged 207.87 points, or 2.07 percent, to 9,823.41, as 26 of its 30 component stocks finished in the red. Leading the downdraft were International Business Machines (NYSE:IBM) and Pfizer (NYSE:PFE), which fell $5.46 and $1.22, respectively. For the week, the INDU erased 821 points, or 7.7 percent, of its value, notching its worst one-week percentage performance since 1989.

Until last week, the blue-chip INDU issues had been bucking the downtrend for most of the new year by consistently trading within a 10,300 to 11,000 range. With this week's sell-off, that range is no more. Now I'm looking at possible range of 9,700 to 10,300, at least based on the weekly chart.

But keep in mind, the INDU is still not in a bear market, which is a 20 percent retracement from a 52-week high, like the other two major market barometers. For the INDU to be officially recognized as being forlorn, it would have to close at 9,140 or lower, so 9,700 should be considered tenuous support at best.

As for the New Economy issues, they just kept right on selling on Friday. The Nasdaq Composite Index (COMPX) fell 59.85 points, or 2.57 percent, to 1,890.86, scrapping a new low unseen since November 1998. For the week, the COMPX fell 161.87 points, or 7.9 percent, marking its seventh straight weekly decline. The COMPX is now trading at a 63 percent discount to its all-time high of 5,132 set back in March 2000.

Despite the COMPX's stubborn refusal to get off the canvas, some bullish technicians think the index could soon find support, at least according to the wedge pattern formed by the December lows and the January highs. Personally, I don't buy the logic because we are only a few downticks from breaking the bottom wedge support. I think the 1998 lows near 1,500 seem more reasonable.

Looking at the broader market, the S&P 500 Index (SPX) fell 23.17 points, or 1.97 percent, to 1,150.39, hitting its lowest level since mid-December 1998. And for the week, the SPX finished off 6.7 percent. The SPX is now trading at a 25 percent discount to its closing high of 1,527 and at a 30 percent discount to Goldman Sachs stock siren Abbey Joseph Cohen's year-end target of 1,650.

Needless to say, with the three major market barometers circling the drain, the market internals on Friday were terrible. Volume was heavy on the NYSE due to triple-witching -- a quarterly phenomenon that sees the simultaneous expiration of futures, options on individual stocks and options on stock indexes. More than 1.5 billion shares traded on the Big Board, the fourth- busiest day in the exchange's history. What's more, that volume was mostly down, with decliners beating advancers by a 21 to 10 margin. As for the Nasdaq, volume was posted at 2.1 billions shares with decliners beating advancers by a 26 to 11 margin.

The specific causes for Friday's declines were numerous. As usual, though, they could be categorized into two major areas of concern -- earnings and economics.

On the earnings front, business software developer Oracle (Nasdaq:ORCL) met lowered quarterly earnings estimates when it posted $0.10 a share late Thursday. Nevertheless, Oracle dropped $0.63 to $14.06 on Friday, continuing a six-week slide that has halved the company's share price.

Also late Thursday, PC giant Compaq Computer (NYSE:CPQ) warned that it expects to report earning of $0.12 to $014 a share for the quarter compared to the consensus estimate for $0.18. The company also said it would eliminate up to 5,000 jobs. On Friday Compaq closed down $0.50 to $18.00.

Not to be outdone, Computer Sciences Corp. (NYSE:CSC), the No. 3 U.S. computer-services provider, said that it expects to earn $0.35 to $0.37 a share for its fourth quarter ending March 30 compared to the First Call estimate of $0.92. Additionally, the company said it will cut 700 to 900 jobs and take a fourth-quarter charge of $100 to $150 million. Computer Sciences was whacked for $21.40 on the news to close at $32.70.

On the economic front, the Producer Price Index (PPI) edged up 0.1 percent in February, matching the consensus estimate and reversing January's nerve-wracking 1.1 percent spike. Meanwhile, industrial production in February fell 0.6 percent, much worse than the expected 0.3 percent drop.

Also on Friday, the University of Michigan consumer sentiment survey was released. The index inched up unexpectedly in March after three months of sharp falls, coming in at 91.8 from 90.6 in February. Economists had expected the index to fall to 89.5. At first glance, the up-tick in consumer sentiment is surprising until you consider that two-thirds of the survey was conducted prior to the week's vast sell-off.

Looking to this week's economic news, all eyes will be focused on Tuesday's Federal Reserve FOMC meeting. Most market watchers are anticipating a 50-basis point cut in the fed funds rate; however, a growing minority is looking for 75-basis points. In fact, according to Bloomberg, nine of the 25 bond dealers who trade directly with the Fed expect the policy-makers to lower rates by 75 basis points next week, up from none the prior week.

The bond market is also counting on an aggressive move on Tuesday. The yield spread between short and long-term debt is once again widening, which suggests that investors anticipate a period of below-average short-term interest rates. Plunging yields on short-term government securities also reflect the flight to quality from equities. On Friday, the 10-year Treasury note was up 6/32 to yield 4.77 percent while the 30-year government bond gained 2/32 to yield 5.27 percent.

Finally, the Consumer Price Index (CPI) is scheduled for release on Wednesday. The CPI is expected to have increased 0.1 percent in February, off from a 0.6 percent increase in January. Less the volatile food and energy sectors, CPI is expected to have increased 0.2 percent, off from 0.3 percent gain in January.

As for earnings, a mixed bag of old and new is set to report this week. Lehman Brothers (NYSE:LEH) and Morgan Stanley Dean Witter (NYSE:MWD) will represent the financial services sector; ConAgra (NYSE:CAG) and Dean Foods (NYSE:DF) will represent the food sector; and 3COM (Nasdaq:COMS), Red Hat (Nasdaq:RHAT) and Micron Technology (NYSE:MU) will represent the technology sector. Look for Micron's earnings release to garner the most attention because of its considerable PC exposure.

Obviously, market sentiment this week will hinge on what the Fed does on Tuesday. Lately, that sentiment hasn't been very bullish. In fact, investors yanked $6.7 billion out of U.S. stock funds in February and likely will pull out more in March, according to fund flow tracker Trim Tabs. If that happens, it will be the industry's worst two-month period since 1990.

What's more, I'm not so sure the Fed's actions on Tuesday will do much to improve sentiment. Should the Fed cut interest rates by 50-basis points, I think market will react with a collective shoulder shrug and then resume selling.

On the other hand, should the Fed cut interest rates by 75-basis points, I think we will get a spike in buying that will be short- lived because the market is beginning to think that traders and investors have unrealistic expectations of lower interest rates lifting the economy (to which I concur).

Talk about a Catch-22.

Then again, sentiment could turn positive just because everyone who has sold has sold, meaning there is little selling pressure left. To that end, the put-call ratio closed at Friday at 1.08, its highest level since October 1998, when it closed at 1.11. This could be a contrarian indictor that the market is indeed ready to turn.

Another possible contrarian indictor is the recent parade of talking heads in the financial press chattering about 1,500 on the COMPX and 9,000 on the INDU. This time last year, many of these pundits were chattering about COMPX 6,000 and INDU 1,200.

For me to be as sure as I can reasonably be that the worst is finally over, I would like to see at least one day of unbridled capitulation with decliners pummeling advancers by at least a 25- to-1 margin on volume of 1.5 billion on the NYSE and 2.5 billion on the Nasdaq.

But then again, who wouldn't?

S.P. Brown


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