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MARKET > Commentary Sunday, April 08, 2001
by: S.P. Brown

Back To Square One

The streak ends at two; that is, if you can call it a streak at all.

Over the past two weekends, I've been keen to mention in my scribblings how the three major market barometers closed Friday's trading session in the black. In doing so, my intention was to offer traders longing to go long this long market a little hope and some sage advice.

Well, so much for good intentions. As we all came to learn 4:00 PM EDT, the three major indices once again reverted to form and closed yet another Friday in the red.

Not that it was a necessarily a forgone conclusion they would do so, because it wasn't. If you'll think back to Thursday, traders were thoroughly (if only fleetingly) inspired by a new-fangled PC box maker and an old-fangled industrial cyclical. Both Dell Computer (Nasdaq:DELL) and Alcoa (NYSE:AA) stepped to the fore that day to declare they would meet the Street's muted quarterly- earnings expectations. In response, traders bid up a major average 400 hundred points and a major index 100 points.

Unfortunately, though, this market takes to momentum like a cat takes to water, so, not surprisingly, much of Thursday's gains were returned on Friday.

But to be fair, traders had plenty of reasons to sell, as the market was swamped by a torrent of bad news. Agilent Technologies (NYSE:A) and Tellabs Inc. (Nasdaq:TLAB), along with a few others, reported that quarterly results would likely disappoint. And if that weren't depressing enough, Pacific Gas & Electric (NYSE:PCG) announced it would file for bankruptcy.

Friday's employment report only aggravated the market's dour mood. The government reported the number of payroll jobs in the economy fell by a startling 86,000 instead of rising by the 50,000 that many economists had expected. This marked the largest drop in jobs since November 1991, which, coincidentally, occurred during the last recession. Meanwhile, the unemployment rate increased to 4.3 percent from 4.2 percent in February, which matched economists' expectations.

Taken in the aggregate, Friday's slate of bad news was enough to turn even the staunchest bull into a bear.

Of course, as most of us are aware, bearish sentiment is most readily manifest on the New Economy exchange, that, ladies and gentlemen, being represented by the Nasdaq Composite Index (COMPX). The tech-heavy index was routed on Friday for 64.64 points, or 3.62 percent, to 1,720.36. The COMPX had little chance of finishing the day in the black, having gapped down 30 points at the open to trade in the 1,725 to 1,725 range for most of the day until it moved down a notch in the final hour of the session to trade between 1,700 and 1,725.

Much of the selling pressure could be attributed to the COMPX's three largest components: Microsoft (Nasdaq:MSFT), Intel (Nasdaq:INTC) and Cisco Systems (Nasdaq:CSCO). The Triplets, as they are affectionately referred to around the Splittrader salt mines, finished the day deep in the red, with Cisco finishing the deepest thanks in large part to Tellabs earnings warnings, which, by the way, did a number on the networking sector, as the AMEX Networking Index (NWX) lost 7.4 percent of its value.

Also contributing to the networking sectors lost cause was Sycamore Networks (Nasdaq:SCMR), which sank $1.81 to $7.25 after warning late Thursday it will report a fiscal third-quarter loss -- as opposed to the profit analysts expected. The company also announced it plans to lay off 13 percent of its work force and take a restructuring charge of $140 million-to-$150 million. Other network equipment makers that fell on Sycamore's news included Juniper Networks (Nasdaq:JNPR), Ciena Corp. (Nasdaq:CIEN) and JDS Uniphase (Nasdaq:JDSU).

If you think it's been difficult to make money in networking stocks this year, you haven't been imagining things. After reaching a high of 868 on January 19th, the NWX has moved only one way, and that's down. In fact, over the past three months, the NWX has lost 59 percent of its value, which isn't surprising considered every networking-related issue mention in this piece, sans Tellabs, is trading at an 80 percent discount or more to its 52-week high. And as for Tellabs, it's trading at a 57 percent discount.

The fall in the networking sector goes a long way to explaining the COMPX's woes, since most of these issues trade on the Nasdaq exchange. Year-to-date, the COMPX is down 40 percent. Still, I think the worst for many high-tech issues is behind us. Over the past few weeks, I've been boring readers with the same graph of the COMPX, which I will do again today. (I'm only doing so because I think it's an important graph, not because I'm a sadist). If you'll notice, the COMPX has been able to trade above its intermediate down trend started in early February. I think this is an important development. I interpret it as meaning selling pressure is abating. In fact, for most of the recent sell-off, volume has been dropping, which means selling pressure could be abating.

All in all, I think these recent developments bode well for the COMPX, particularly if it can break through resistance at 1,800.

Unfortunately, I don't have the same warm fuzzy feeling for the Old Economy despite its ability to weather the selling storm better than the New Economy. Case in point, while the COMPX experienced a 3.62 percent loss on Friday, the Dow Jones Industrial Average (INDU) experienced a 1.28 percent lost, as it closed down 126.96 points to 9,791.09.

Still, I don't like the idea that the Old Economy issues have yet to take their lumps. The INDU is not considered to be in a bear market (a close of 9,378 or lower). I think it's important that the INDU spend a little time in purgatory before it attempts a sustainable rally.

To that end, the INDU is looking weak, at least according to the charts. Since obliterating its diamond formation last month, the INDU has confirmed a longer-term down trend began back in January 2000. At this point, I would not be surprised to see the INDU test support at its lower regression line near 9,150. In fact, I think it would be healthy. I think once the INDU closes below 9,378 we will finally see the full capitulation that this market is so longing for.

As for the broader market barometer, the S&P 500 Index (SPX), like the COMPX, confirmed its bear market status on Friday, closing down 22.97 points, or 1.99 percent, to 1,128.47. And in case you're wondering, Abbey Joseph Cohen has finally lowered her year-end target on the SPX from 1,650, though she hasn't given an exact replacement figure.

In stock news, earnings concerns continued to be the main byline. Cell-phone chipmaker Motorola (NYSE:MOT) got whacked for $3.45 to close at $11.50 after a Credit Suisse First Boston analyst said the company probably won't meet analyst profit expectations for the year. Fueling the selling flames was a Bloomberg News columnist, who suggested the company might face a financial crisis due to an inability to refinance short-term debt should its debt rating be cut. The company denied the Bloomberg assertion and said it is "financially sound."

Doing Motorola one better was electronics retailer RadioShack Corp. (NYSE:RSH), which lost $10.20, or 26 percent, to $28.30 after reporting first-quarter earnings will fall to $0.31 to $0.33. The company was expected to earn $0.38, according to a survey of analysts by First Call.

Another notable loser was our former Current Play list member MBIA (NYSE:MBI), which tanked $7.69 to $75.10. This stock had been a strong performer for us until the Pacific Gas & Electric debacle hit the wires. MBIA has direct net par exposure to PG&E of approximately $590 million of which about 61 percent is secured by first mortgage bonds with the remainder being senior unsecured bonds.

The beneficiary of the equity market's foibles on Friday was the Treasury market. The 10-year Treasury note climbed 28/32 to yield 4.865 percent while the 30-year government bond jumped 1 5/32 to yield 5.45 percent. Overall, the yield curve has grown increasingly steep over the past few months, as spreads between short- and long-term bonds have widened to levels not seen since 1996. Historically, a positively slopped yield curved has boded well for the equity markets. Roughly speaking, when the yield curve gets steeper (as the gap between short and long rates widens), monetary policy is stimulating the economy and growth will likely increase. The steep yield curve of 1994 preceded the economic boom that continued through mid-2000.

On the economic front, there was little worth noting on Friday aside from the unemployment report (if that wasn't enough). This week, the major economic data releases won't be released until late in the week. Retail sales, the Producer Price Index (PPI), and, core PPI are due on Thursday. Retail sales are forecasted to post flat for March, up from a 0.2 percent decline in February. PPI is expected to have risen 0.1 percent in March, unchanged from the prior month's posting. Less food and energy sectors, core PPI is expected to have also increased 0.1 percent, up from a 0.3 percent decline in February.

On Friday business inventories and University of Michigan Confidence will be released. Business inventories are predicted to have gained 0.3 percent in February, off slightly from a 0.4 percent increase in January. The Michigan Confidence, a closely watched gauge of consumer sentiment, is forecasted to have dropped (not surprisingly) to 90.5 in preliminary estimate for this month, off from its final March index reading of 91.5.

With so little happening on the economic front early in the week, look for earnings to once again set the market's mood. In fact, earning season returns in full force this week as a slew of companies report their fiscal first quarter earnings. Companies reporting during this week include Motorola, which will call in its first-quarter results on Tuesday, and Yahoo (Nasdaq:YHOO), whose earnings announcement will punctuate Wednesday's session. Abbott Laboratories (NYSE:ABT), Biogen (Nasdaq:BGEN), Handspring (Nasdaq:HAND), and Juniper Networks (Nasdaq:JNPR) will all report their earnings on Thursday.

If you are going to trade this week, expected increased volatility in the markets, particularly if the trend in corporate earnings is much better or much worse than expected. I suspect it will be worse. First Call has counted 808 announcements of disappointing first-quarter results so far -- the highest total for any quarter in the five years the firm has been tracking them.

Still, there could be a silver lining surrounding the earnings clouds. Should companies fail to meet their lowered estimates or issue further warnings about the rest of the year, the Federal Reserve could be forced to lower rates before its scheduled May 16th FOMC meeting. In fact, Merrill Lynch even went as far as to issue a report Friday morning suggesting the weak employment data could spur more aggressive, inter-meeting cuts by the Fed, possibly cutting as much as 50 basis points this week.

So, if volatility is once again the norm, you might want to heading for the sidelines, as I doubt few stocks will build much momentum this week. On the other hand, if you are the more adventurous type, you might consider straddling or strangling (optionally speaking of course) a few high-volatility stocks. I know this strategy has worked well for a few of our readers over the past month.

S.P. Brown


Copyright 2001

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