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MARKET > Commentary Monday, June 18, 2001
by: Derek E. Baltimore
Contributing Editor

Level 3 Gets Leveled

Before the market opened this morning, we got our typical slew of earnings warnings and downgrades, predominately from the battered and beaten down telecom sector. As was widely expected, Level 3 Communications (NASDAQ:LVLT) lowered revenue guidance and announced job cuts totaling 25% of its workforce, citing the continued slowdown of spending for bandwidth by carriers. Shares of the Broomfield, CO-based company have now lost more than 40% of their value since June 1, continuing their downward ways today, shedding another $1.65 or 21% to $5.97.

Goldman did their part to pressure the COMPX by lowering estimates on the internet infrastructure sector, slashing revenue estimates on EXDS, ISLD and MFNX. The broker cited the continued dot-com erosion and expected pricing pressures in the second half of 2001 as reasons for their actions.

Not to be left out in the cold, Salomon Smith Barney made cautious comments on software giant Microsoft, citing risk in the company's June and September quarters' EPS figures, although they reiterated their Buy rating and $85.00 target. Microsoft (NASDAQ:MSFT) finished the day down $1.14 or 1.68% at $66.88.

These negative events, coupled with the dog days of summer, equaled a typical June session, with the major averages trading just slightly on either side of the flat line for most of the day, though the COMPX proved the weakest link. We did find some solace in today's market action, considering the highly negative technical picture seen on daily charts of the Dow, Nasdaq and S&P 500. With closes on Friday below the 50-dmas for the SPX and COMPX, and below the more crucial 200-dma for the DOW, the opportunity for much lower ground did exist this morning. Furthermore, major sectors such as software, semiconductors and networking are not offering support, and in fact dragged down traders' optimism for a second half recovery due to their bearish guidance and lack of visibility. Nonetheless, a minor loss of just 1.9% by the tech heavy Nasdaq Composite could also be viewed as somewhat positive, although it seems like grasping for straws.

Perhaps the strength, or lack of noteworthy weakness, was due to anticipation of database software giant Oracle earnings report, which occurred after the bell. The firm's CEO, the much touted Larry Ellison, made bullish comments, or non-bearish comments rather, in an interview on CNBC last Thursday, more or less saying that the company would meet estimates and was seeing a drastic improvement in its business. Oracle reported revenues of $3.2 billion, and beat estimates by a penny with a profit of $0.15 per share in the latest quarter. Oracle closed at $14.84, down $0.16, but was seen bid at $15.41 in the after market.

Chart of ORCL

For the day, The Dow Jones Industrial Average (INDU) tacked on 21 points, or 0.2 percent, ending at 10,645. The Nasdaq Composite (COMPX) lost 39 points, or 1.96 percent, to 1,988 and the Nasdaq 100 Index (NDX.X) slid 35 points, or 2.1 percent, to 1,666. The S&P 500 (SPX.X) shed 5.9 points or 0.49%, settling at 1208, while the Russell 2000 (RUT.X) dropped 4.5 points or 0.9% to 490.54. Volume was less than confirming on any of the major indexes, coming in at 1.1 billion shares changing hands on the NYSE and 1.5 billion on the Nasdaq.

In the bond pits, traders continued to bid up the price of shorter dated maturities as the odds for a wider than originally expected rate cut by the FOMC next week continue to rise. Last week's tame inflation data coupled with a still weakening employment and industrial production picture could give the Fed the "all green" to cut rates by 50 basis points at its meeting June 26-27. A light economic calendar this week will likely cap gains achieved in the credit markets, though continued selling in equities could result in a flight to safety, furthering profits. Two-year notes, among the securities most sensitive to overnight rates set by the Fed, gained 1/32 to 100 17/32. Yields fell 2 basis points to 3.95 percent, the lowest since October 1998. Five-year notes lost 1/32 to 99 20/32, pushing yields up 1 basis point to 4.71 percent.

Looking at the technical snapshot for the US major markets, it could be better. As was mentioned in this weekend's wrap, the closing below the 200-dma by the INDU is the most daunting for traders, although some may find solace in the fact a settlement above this key mark was achieved Monday. Volume lightened up, giving little confirmation of the bounce off of 10,611, and providing reason to be suspicious. Internals were mixed as well, further clouding one's ability to make a direction call for the INDU near- term. For the record, new 52-week highs beat new 52-week lows by a measure of nine to six at the NYSE. Decliners beat advancers by a margin of 17 to 13 and declining volume was decidedly higher than advancing volume, finishing at 6829 million shares to 409 million.

Chart of the DOW

Support is likely to come into play in the DJIA near the 10,450-10,500-range, while a closing north of the 10,785/50-dma point would be a signal that the bulls have reaffirmed control.

As for the COMPX, the gap still needs to be filled from 4/17-4/18 (1923-2005), and will likely occur in the near term. An immediate floor is seen at 1900, but a breaching of this point could spell a return to the lows, as disturbing as that sounds.

Chart of the COMPX

A fulfilling of the head and shoulders pattern on the daily chart is playing out to a tee, and unless bulls step up to the plate around 1900, trouble with a capital T is coming to town. As for my humble opinion, as bearish as it looks, I sincerely doubt a return to the lows occurs. Several factors are involved with this decision, not the least of which is the aggressive rate reductions by the FOMC, with still more in the pipeline. I actually feel that the Fed will have to raise rates in the 2nd quarter of 2002, probably as the market is just getting its footing. Secondly, we are now at the bottom of a well defined trading range, and much of the bad news from tech has been heard, although there will be surely a bombshell here and there in the next 5-7 days. The point is this: With 2000 being the floor for the COMPX since mid-April, coupled with the fact that end of quarter fund selling--capturing gains seen from 4/15--5/22--the downturn is likely coming to an end, an argument can be made by institutions. Decent rewards may be in the cards going long some stock in here.

Wrapping Up and Looking Forward

While a valid argument can be made to purchase some stock at current levels, only those with some history in the market would tell you to get long much with the exception of financials and deep cyclicals, which by all measures should outperform the broader market in a declining interest rate environment. Despite bonds rallying of late, the underlying story from significant players in the credit markets is that the Fed is very near the end of their rate cutting cycle, unless we are to sink into a long, deep recession. Few believe this to be the case, but Japan, of course, felt the same way a few years back.

Chart of the ARMS 10-Day

Look for technology to trade in a tight range in the next few sessions, although short-term indicators such as the 10-day ARMS index indicate very oversold conditions, allowing for a higher surge at a moments notice. Sometimes you have to ignore the crowd, picking up the baby thrown out with the bath water. This feels like one of those times, especially with Alan and the boys reloading.

Derek E. Baltimore
Contributing Editor


Copyright 2001

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