Market Update for 3/24/2002

The Winning Streak Ends! Sometimes it’s easy to write this newsletter as the words just have to be captured on paper. But then, sometimes it’s a struggle to find anything interesting in the markets to write about. So last week, Lettie and I decided to take a break and visit the desert (for inspiration) and to watch some world class tennis. And Wow, what a difference a week makes! The last two weeks capped a five week winning streak for the Dow that left it within a handful of points from 10600 at each day's close. Last week started well with Monday and Tuesday seeing the Dow trade well over 10,650 both days, as investors expected the Fed to leave interest rates unchanged and say positive things about the economic recovery. All of that happened as expected but was quickly followed by more cautionary comments and fears of an aggressive Fed in the near future. Those fears subsided quickly when they were replaced with even greater fears of a new recession in our future and a flurry of additional earnings warnings. Suddenly the smells of spring that greet a bulls nose seemed to be more like that of a stockyard on a warm summer's day. Leading the big news we will start with the controversy over GE. As the largest company in the Dow it has a major impact in the Dow’s direction. Unfortunately that direction was down after a negative news story. After trading at a high of $40.55 the stock dropped to a five week low--under $37 on Wednesday. Bill Gross, probably the world’s most famous bond fund manager (at PIMCO of Newport Beach) said he was concerned about their disclosure practices and their heavy debt load. GE raised $11 billion in new short-term bonds last week and said they could go out for another $50 billion this week. This caused a stampede out of the stock which only slowed after GE announced on Friday that they were reaffirming their 2002 full year earnings and were going to reduce their short term debt going forward. Unfortunately investors didn’t believe it and there was nobody to buy back into the stock after the calming comments by management. The volume was only 30 million shares compared to 56 million on Thursday. The problem, it appears, is that nobody wants the stock--even at $37. If this trend continues then the Dow will have one more anchor to drag along. But the Dow problems paled in significance to the ramifications from the Philadelphia Fed Survey on Thursday. Their Index headline number was 11.4 (much less than the expected 16). This was the first drop since November and the new orders component was the weakest since December. This brought an immediate wave of warnings that the economic rebound that everyone had been bragging about was just an inventory correction process and that real demand was simply absent. The double dip crowd took center stage and the markets felt the impact. Historians pointed to the past when almost every prior recession was met with a second dip after phase 1 was seen. Adding to the worry about another dip were warnings from several companies that they would miss earnings and they saw no recovery in their future. But wait a minute! If you think about it this is nothing new. Everybody except maybe the chipmakers has been saying "still no visibility" all month but the bulls simply ignored it. Even GE said they saw no recovery in their future when they reaffirmed earnings the first time. Solectron, a premiere technology company, announced earnings in-line with already lowered estimates but warned that the next quarter will be lower again. The biggest comment was that much of their $4 billion in outstanding orders may get pushed into the end of NEXT YEAR. The contract electronics sector, where chips meet boards and become actual equipment, is still very weak. Reading between the lines indicates that there are no orders for completed equipment--if production is being delayed as much as 18 months. Does this mean the inventory correction orders are already over and companies are expecting another dip before things get better? It would appear so to investors. Even the oil services sector, which had been on a roll, came up dry on Friday. Baker Hughes warned that declining rig counts would impact their earnings and the stock dropped -2.55. Then, quick on the trigger, Salomon Smith Barney decided that none of these companies were important enough clients, so they downgraded BHI, RDC, NBR, SLB and TDW. The newbie analyst said weak Latin American economies and slowing consumption due to higher oil prices made the sector overpriced by as much as 20%. Blah…blah…blah. Where did all the bullishness go? Many analysts have been preaching the overpriced market mantra for several weeks and it only intensified after the +1000 point Dow gain in the last five weeks. This is a constant babble and I do not want to place too much emphasis on its credibility. Still, when investors start looking for excuses in times of trouble that is the first one they find. Anyone looking closer than the talking heads on stock TV knows that other factors are more important. First there is that +1000 point gain. Did anyone expect there to be no profit taking? Of course not! Only the hobby traders get caught flat-footed after those types of gains. Also, historically speaking, the last five trading days of March have also been rough the last several years. This is a normal cyclical thing, which should be expected. Add in all the warnings and double dip talk and it just becomes more likely. For next week the Dow still looks like it could be under pressure. There was an intra-day bottom at 10400 on Friday but it could just be a resting place instead of a real bottom. The S&P has the same thing at about 1145 but you would be stretching it to call it serious price support. 1850 is performing the same function on the NASDAQ. I would like to stress that these are not strong price support levels but simply areas where some buyers stepped in to snag a few shares at a discount. The name of the game appears to be "dips are for snacking" not buying. Mutual Funds are seeing cash come into accounts but they are not rushing out to buy anything. According to TrimTabs.com $4.4 billion in new cash flowed into funds for the week ended on Wednesday compared to a whopping $7.6 billion the prior week. In comparison to the past couple months this is a huge inflow. This apparently means consumers saw the Dow about to breakout to a new post attack high and wanted to buy a ticket for the rally. This "headline" buying is part of the problem that is pushing the CBOE Volatility Index (VIX—one of my favorite indicators) to new lows. The herd buys the tops and sells the bottoms and considering the $12 billion inflow of cash over the last two weeks you would be hard pressed not to see the trend. The VIX closed under 20 on Friday at 19.62. Does anyone else think it is strange that the volatility indexes fell on a day the markets dropped? This is contrary to the conventional trends. People are simply so sure that the markets are going up that they are not buying “Puts” to protect themselves. THIS IS DANGEROUS COMPLACENCY IN ITS HIGHEST FORM. What should we as investors do? I think the answer is clear. The closer we get to April earnings the more earnings warnings we will see. There is a stronger possibility that the markets will move sideways or down instead of up. We have failed so many times at 10635/1175 that investors now want to see if there is a bottom. Once the market is assured there is support nearby then investors will feel better about buying stocks and attempting the breakout again regardless of the possibility of a second economic dip ahead. We only want to be accumulating long-term positions if the market can take out the prior price resistance. The number for the S&P is 1155. Should the markets continue to show weakness I will sell short the S&P below 1140 by purchasing shares of the Rydex Tempest 500 Mutual Fund. This fund goes up as the market falls. The week before Good Friday is typically flat to down. Mutual Fund managers window dress their portfolios the prior week in order to take a long holiday. The first two days after Easter are normally bullish as investors pickup bargains from the prior weeks’ drop. Volume next week could be even worse than the 1.2B NYSE, 1.3B NASDAQ on Friday. Any surprise news events could produce some serious market swings. Be prepared. Mark Pivan Legal Stuff: The information contained in this report is based on sources believed to be reliable, but is neither all-inclusive nor guaranteed. Opinions reflect my judgement at a particular time and are subject to change. This report is derived from, and may contain examples of, forward-looking estimates and projections, which involve risks and uncertainties. The actual results may vary significantly from the forward-looking estimates and projections. In the course of regular business, I may be long or short in the securities mentioned. I may make either purchases and/or sales of them from time to time in the open market or otherwise.