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MARKET > Commentary Sunday, April 01, 2001
by: S.P. Brown

Prelude To A Rally?

Okay, so maybe I am jumping the gun, but for the second consecutive week, the three major indices closed a Friday in the black. Only a fortnight again such an event seemed as unlikely as a British cow avoiding a premature trip to the abattoir.

To be sure, the three major indices have performed miserably through the first quarter of 2001. The Nasdaq Composite Index (COMPX) fell 25.5 percent after falling for the last three quarters in 2000, marking the first time it has tanked for a full 12-month cycle since 1984.

Not that 2001 has been any kinder to blue-chip and broader markets, because it hasn't. The Dow Jones Industrial Average (INDU) finished the quarter down 8.4 percent, posting its worst quarter since 1978 and snapping a two-quarter winning streak that was sparked by traders' search for anything sans tech. Meanwhile, the S&P 500 Index (SPX) finished off 12 percent, posting, like the COMPX, its fourth-straight quarterly loss.

But if I may be so bold as to invoke a meaningless cliché or two, that was then and this is now and sunk costs are sunk. In other words, the future is what matters, and if we can say that the future began on Friday, then we can say that it's off to a respectable start (just don't say that the future began on Thursday or Wednesday or you'll ruin my segue).

To that end, the COMPX closed Friday with a gain of 19.69 points, or 1.08 percent, to 1,840.26. Leading the COMPX advance were four issues that couldn't catch a break to save their lives earlier in the week. Cisco Systems (Nasdaq:CSCO), Sun Microsystems (Nasdaq:SUNW), JDS Uniphase (Nasdaq:JDSU) and Oracle (Nasdaq:ORCL) all managed to post a modest gain.

Still, that wasn't enough to erase earlier losses. For the week, the COMPX jettisoned 4.6 percent of its value.

Despite tech's mounting losses, I'm becoming more bullish on the COMPX. For all of last week, the COMPX remained above its two- month long downtrend. What's more, the bottom line of a popular wedge formation suggests that 1,750 is the downside limit. Obviously, there is still risk, but with many big-cap tech issues trading at 60 to 70 percent discounts (including the aforementioned tech quartet) to their 52-week highs, I'm thinking that the risk/reward scenario on the COMPX is favoring long-side traders.

My bullish sentiment also applies to the Old Economy. On Friday, the INDU rose 79.72 points, or 0.81 percent, to 9,878.78, which means the average has now put 500 points between itself and the official bear market close of 9,378. The INDU was buoyed by American Express (NYSE:AXP), which gained $2.34 to $41.30 on speculation that Citigroup (NYSE:C) may be interested in making an offer for the company. Other notable winners included J.P. Morgan Chase (NYSE:JPM), Exxon Mobil (NYSE:XOM), International Paper (NYSE:IP) and Alcoa (NYSE:AA).

Moreover, for the week, the INDU posted a 3.9 percent gain.

Much ado has been made of the INDU obliterating its 50 percent retracement from its all-time high of 11,720. However, I think it's more noteworthy that the INDU broke through its bottom regression line, which could provide immediate resistance at 10,000. Should the INDU break this resistance (which I think could happen soon because of recent strong momentum), the next significant resistance level comes at 10,750, the top of the downward regression. This is in contrast to the 50-percent retracement at 10,500, which many technicians are pointing to as the next resistance level. I don't buy it, though. To me, 10,500 represents eventual support, not current resistance.

Of course, as many traders are aware, we can't get too gung-ho about this market until the official arbiter of bull and bear markets, the S&P 500 Index (SPX), recovers. On Friday, this broad-market index rose 12.38 percent, or 1.08 percent, to 1,160.33, meaning its now trading at 24 percent discount to its all-time closing high of 1,527.

However, I think the worst may be over for the SPX, particularly if it has caught support at its intermediate upward trendline, which, according to the chart, it appears it has.

As for stock news on Friday, more specifically Splittrader stock news, our Current Play list continues to hold its own. Our biggest winner this week was electronic game maker THQ Inc. (Nasdaq:THQI), which gained 10.1 percent for the week to close at $38.00. The second biggest gainer was mortgage insurer Radian Group (NYSE:RDN), which moved higher 9.5 percent to 67.75.

Regrettably, there were losers. The biggest loser was low-end retailer Rent-A-Center (Nasdaq:RCII), which gave back 6.7 percent. Another notable loser was Smithfield Foods (NYSE:SFD). Smithfield had the misfortune of being associated with the Tyson Foods (NYSE:TSN) and IPB Inc. (NYSE:IBP) takeover fiasco.

In a move that humbled many an arbitrageur's portfolio, Tyson, the nation's largest poultry processor, recanted its $30-a-share takeover offer for IPB, the nation's largest meatpacker. With Tyson headed for the exits, IBP plunged $6.39 to $16.40 while Tyson rose $1.97 to $13.47.

Enter Smithfield, the nation's largest pork processor. Given its plunge, IBP is once again perceived to be an attractive takeover candidate, since it's now trading for roughly 10 times projected 2001 profits of $1.50 a share. This had many arbs thinking that Smithfield may make a bid for IBP.

In other words, they sold Smithfield on Friday. The company's shares tanked $5.25 to $32.50 on Friday. We were stopped out at $33.25 despite having a stop-loss set at $35.25 because of the stock's gap-down open. Still, we were able to exit with a small gain. However, had Tyson stuck to its guns, Smithfield would have been our biggest gainer for the week. Oh, well.

While we're on the subject of our Current Play list picks, here's an interesting tidbit. Over the past five months, the Splittrader portfolio of plays has lost 2 percent in value. Granted, losses are nothing to brag about; however, over the same time period the Dow Jones Industrial Average (INDU) has lost 9 percent, the Russell 2000 Index (RUT) has lost 9 percent, the S&P 500 Index (SPX) has lost 18 percent, the Wilshire 5000 Total Market Index (TMW) has lost 19 percent and Nasdaq Composite Index (COMPX) has lost 44 percent.

Keep in mind, too, that we employ a long-only strategy (enacted in October 2000). What's more, the majority of our picks are split run and split candidates, meaning there still is value to be created anticipating stocks that could split.

Here's another consideration: we don't cherry pick our plays to represent our gains. Many financial information sites will post their best picks on their start page, leading readers to believe that these picks are representative of overall portfolio performance. WE REFUSE TO DO THAT. In fact, since we switched to a long-only strategy, we've kept a detailed Excel spreadsheet of all our picks (November to the present), which I'll avail to any reader for the asking (e-mail And if you want to see all of our play results since our inception, just click on the "Play Results" section on the left-hand side of our homepage.

But enough of us, let's see what else happened on Friday.

In economic news, the University of Michigan consumer sentiment index improved modestly in March, coming in at 91.5 vs. February's 90.6 reading, snapping a three-month decline. Street analysts had predicted numbers from 90.2 to 91.0. The survey seemed to indicate that consumers aren't as depressed about the stock market's losses as the experts thought.

Also on Friday, the Chicago Purchasing Managers (CPM) fell to 35.0 percent in March, its lowest reading in 19 years. This (CPM) index is often an indicator of the National Association of Purchasing Management Index (NAPM), which is due next week and is traditionally the first reading on the economy of every month. This NAPM report could sway the Fed to consider an inter-FOMC meeting interest rate cut.

Speaking of NAPM, this index reading will kick off this week's slate of economic data releases on Monday. The NAPM index is forecasted to post at 42.5 this month, up from 41.9 in February. Still, a reading less than 50 is indicative of a contracting economy.

On Tuesday, factory orders for February are due for release and are predicted to have increased 0.2 percent, up sharply from a 3.8 percent decrease in January.

Finally, on Friday, we get the week's most anticipated economic data set with the unemployment report, which is expected to rise slightly to 4.3 percent this month, up from 4.2 percent last month. Moreover, average hourly earnings -- the gauge of wage inflation most closely watched by the Fed -- are expected to increase 0.3 percent this month, off from a 0.5 percent increase in the prior month. Overall, the U.S. economy is expected to have added 75,000 non-farm jobs in March, off from the 135,000 non-farm jobs added in February.

Taken together, the week's economic reports should help investors anticipate whether the economy is approaching a V-shaped (quick), U-shaped (slow-but-sure) or L-shaped (not in the cards) recovery.

As for the Federal Reserve, it will likely remain at the back of the bus, at least through this week, leaving the driving to corporate earnings, which, so far this year, have driven the bus like Mr. Magoo. So far, 984 companies have issued comments about their earnings and 682 have been earnings warnings. In the year- ago period, 272 companies issued comments and only 122 were negative. Keep in mind, the confessional season begins in earnest next week.

This week's earnings will bring announcements from major electronics retailers Circuit City (NYSE:AA) and Best Buy (NYSE:BBY), as well as blue-chip manufacturing bellwether Alcoa (NYSE:AA).

Don't expect this trio to knock your socks off. According to analysts surveyed by First Call, S&P 500 companies' earnings will drop 8 percent this quarter and 6 percent in the second quarter.

Despite the continued dearth of positive earnings news, I still think you have good reason to turn that frown upside down. Like I've said in the past, I think the worst is over. Everything we currently know about earnings, the economy and the Fed is priced into today's security prices.

The fact is, with everyone expecting the worst, it's not going to take much good news to get this market moving in the right direction again.

S.P. Brown

Editors Note:

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