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4/03/02 Investment House Daily
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MARKET ALERT SERVICE

Target alerts hit this week: MSFT put (+2.70 per option); IGT put (+4 per option); MTEC (+7.21; +22%); AHC (+$10.20); NVDA put (+$4.28 per option); RTN (+$7.25; +19%); ZRAN (+$7.65; +19%)

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http://www.investmenthouse.com/alertdly.htm

SUMMARY:
- More selling on the same worries.
- Earnings warnings tapering off, but investors want immediate results.
- Economic numbers very solid, rate hike not so certain now.
- Indexes breach support, recover slightly on mixed volume.

Selling continues on continued worries.

The war intensity continues, prolonging the uncertainty about oil prices and the ability of western economies to continue economic recovery. That fear was seen in the pressure on the cyclical stocks that helped lead the market higher and kept on delivering during this last two months of fade on the overall market. Today even these stocks were under analyst valuation attack with claims that they have fully priced in the recovery. With continuing economic improvement under question given armed conflict in the oil belt, the whole market felt the pressure.

Earnings warnings continued to plague the market as well. WCOM is set to reduce staff by 10% (7500 workers). Software stocks were warning again before the open and after the close tonight (CPWR is cutting its estimates by 50%). BMY warned big after hours and was getting crushed. It was already a full dive before this announcement, however.

Downgrades were in the picture again as well. As noted cyclical stocks were suffering due to valuation calls; if a stock moves higher in this market the analysts and their recently adopted dour view of life are quick to label it overvalued. Such is life in a market shaking off its longest bear in 25 years. MU felt the whip with Morgan Stanley cutting it to underweight (i.e., sell). Its 200 day MVA consolidation gave way.

Earnings warnings continue to taper.

The headlines on the software sector have been bad with ORCL a few weeks back and the PSFT Tuesday opened the gates for a lot more software warnings. ITWO, SMFT, IWOV, INKT, and CPWR all warned (CPWR slashing estimates by 50%). Software, particularly enterprise (business) software, often does not know how its quarter is going to be until the last few weeks. Thus they are usually late in the game in issuing warnings. The raft we have seen comes as these companies admit the orders did not come in.

Investors are apparently reading the software warnings as a sign that earnings will be generally crappy once again. PSFT was supposedly a surprise. The others, well, they have been lagging badly for quite a while. What is being somewhat overlooked are the fewer warnings overall from those companies that had a better picture earlier than software of what the quarter was going to be.

Negative earnings warnings for Q1 are running at 421 versus 722 in the prior quarter. In technology there are 142 downside warnings versus 298 prior. This is not a landslide turn, but it shows a slowing of warnings and it also showing that more companies, those that had a bead on their quarter ahead of software, did not warn and thus are most likely going to hit or beat estimates.

This is showing up in companies such as DELL, reaffirming earnings after hours and saying revenues were ahead of consensus. BBBY beat the street by 2 cents and was up $1.20 from the close. HLYW boosted its quarter and its year on the back of DVD movie sales. SKX (shoes) guided higher as well. JNY (apparel) said its Q1 will exceed estimates. It is not going to be a powerful earnings season, but it is going to be far from the abysmal results seen the past four quarters.

Will a better earnings quarter be enough to spark any move higher? With ongoing conflict and uncertainties about the future economic strength, investors are going to be again in a 'what is happening in the current quarter' mode. If the economic numbers were just rocking along as they have been doing and there was no threat of rising oil prices or spreading of war it may have been enough. With these additional areas of uncertainty, it might provide a rally but whether it fuels a sustainable move is very questionable.

THE ECONOMY

Services ISM pulls back but beats expectations.
After posting the strongest surge since November 2000 in February (58.7), the services index cooled a bit to 57.3, still beating estimates pegged at 57. Again this shows continued expansion in the services sector if not the breakneck pace it showed in February. New orders received the most focus as they indicate future activity. They were down to 54.9 from the 57.3 jump in February. Still not shabby at all. Prices paid moved to 53.0 from 50.0, another concern for inflation hawks (but not much of one). Employment was better but still contracting: 45.5 from 43.6 in February. Again, this means that the pace of contraction is slowing, not that more people are going to work in the service sector. It would take a reading over 50 to show that.

This news hit the markets like cold water. In a market struggling to find traction against earnings fears and some tech disappointments, a solid yet weaker number did not help. It did not say 'things are still smoking to the upside', and without a real positive catalyst, investors saw this as a sign that the recovery is not going to pull IT spending and thus technology higher in the near future.

Fed Funds Futures contract slipping.
The FFF had been pricing in a 25 basis point hike at the May FOMC meeting. While this was the talk early on when the strong economic numbers started to hit, we noted it was a long way out. The FFF contract as a predictor works best in a two week or less window before the actual meeting. Otherwise it is just like any other market: it leans a certain way based on the available data. As more data comes to bear or as it gets to the final stages of the decision-making process, the chaff is shaken out. After the ISM Services numbers hit the wire, the 50%+ chance of a 25 basis point hike fell to a 44% chance. Above 50% is a decent reading; 75% is obviously more of a lock. A 44% reading is not much of a chance when looking at how the FFF contract historically works as a predictor. Moreover, Fed governor Moskow today stated that the economy was far from out of the woods, that there were still considerable risks as to whether final demand would be there when needed to buy those goods produced after an inventory rebuilding phase.

Again it is still a long way from the actual meeting and even the 44% chance can improve once more. With the trouble in the Middle East, some are saying rising fuel costs associated with that could cause the Fed to hike rates to stave off inflation. There they go again. That was the same argument back in the Fall of 2000 when prices were rising because of OPEC production cuts. The theory is, gee, oil prices are rising, and that means other prices could rise as well, and that would be inflationary. The Fed may have to raise rates to prevent inflation.

As we noted then, there are HUGE flaws with that simplistic, even childish thinking. First, raising interest rates won't stop the current Middle East fighting and reduce price pressure on oil any more than raising interest rates would stop OPEC from limiting production back in 2000. The two are just not related. Yes it could slow the pace of economic activity and thus the need for more oil and that would ease pricing pressure, but heck, we just got out of one recession. That brings up point two that also has an answer in 2000: the Fed knew that the economy was going downhill fast (though it waited until January 3, 2001 to cut rates) and the last thing it could do was raise rates after torpedoing the economy in 2000 and 2001 as a result of its prior unwise rate hikes. Calls for rate hikes were so far off the market it was ludicrous, but the market factors in a lot of fear.

The Fed is seeing some higher prices paid on the wholesale end, no doubt as a result of higher oil prices. In 1984 and 1992, however, the increased oil prices never made it to the consumer side. There is still NO pricing power with manufacturers; the economy is nowhere near strong enough to support that. The CPI (consumer prices) may rise based on purchases of gasoline by consumers, but in this economy we do not think that the energy price increases will pass through in manufactured goods just as they did not in the 1991-1992 recession. Economy too weak, and no pricing power. Thus, raising rates on fear of higher oil prices is not a valid reason, and as we saw in 2000, the Fed was not going to raise rates based on that factor with a very poor economy. That is the mistake that was made back in 1973 and 1974, and we paid for that until 1982 with the tax cuts that launched the 20 years of prosperity.

The Fed can still raise rates from the current 1.75% level for reasons OTHER than immediate inflation concerns. The current rate is acting as a heavy foot on the economic accelerator; money supply is still surging. The Fed has room to back off 75 basis points without hurting things much. Will it do it in May? Probably not.

THE MARKET

All three major indexes undercut what is more defined support during Wednesday's session. They all rallied right back up to that point and stopped. Volume was higher on the NYSE and a hair lower on the Nasdaq. The A/D line was worse but not a rout. The put/call ratio closed at 0.88. The breach of support is something to be very cautious of, but indexes or stocks in trading ranges can break support or resistance, trade around that level for a bit and then return to the trading range. The slightly increased volume the past two sessions indicates there is more selling here, but not breakaway selling. There were some programs kicking in but not massive sell programs. With the put/call ratio at 0.88 we are not ready to pile into the downside on this tepid breach of support. Many big stocks that sold Tuesday did not sell much today. We will see how it plays out here around this support level. The indexes got a push out of their ranged, but it was not a hard shove just yet.

Our upside plays were mixed with some continuing their runs higher and others pushed back on us. We are employing trailing stop losses, and many of the stop alerts issued are still putting money in our pockets (not as much as we wanted on those plays), preventing losses, or cutting losses substantially above 7%. We also had some downside plays hit the target again today on the selling, not a surprising development. The market is tough, tough right at this juncture as the economy is still improving but the market is uncertain, refusing to commit definitively. We are being extremely selective in our plays that go onto the report and are making certain they are meeting our criteria for buys. If volume is not where we want it but the move is looking solid early, we are not launching into a full position until we see it improve; then we pick up more positions on a test. There is no need to chase every possible play in this market. We take a lot of positions and have had to execute a lot of trailing stops in this market. Focus on the plays that make sense to you. If it works great. If it does not, cut quickly. In any case use trailing stops during these times of low volume sell offs.

Put/Call Ratio (CBOE): 0.88 (+0.03). Hit that 0.88 level we discussed Tuesday night that has helped set off minor rallies in the past. With the support breach and recovery back up to that support we could see a relief rally start this week or early next as the news about the Middle East fighting is no longer new news.

Nasdaq

Undercut 1800 then 1775, but rebounded to close at the lower support level. Volume was fractionally lighter. Not a major breakdown. We could see further selling tomorrow and then the index starts to try and put together a relief bounce.

Stats: -20.05 (-1.1%) to close at 1785.35. Wow, only a 1.1% drop.
Volume: 1.685 billion (-0.7%). Basically flat volume on the continued selling. The selling volume did not rise on further selling and a recovery back to support. Perhaps a relief bounce is in store.

Up volume: 418 million (+226 million)
Down volume: 1.219 billion 1.489 billion (-270 million)

A/D and Hi/Lo: Decliners actually fell to 1.55 to 1 (1.58 to 1 Tuesday). Market action did not deteriorate at least.

New highs: 107 (-18)
New lows: 53 (+2)

The Chart: http://www.investmenthouse.com/cd/$compq.html

A brief game with positive numbers early quickly gave way with 1800 succumbing and then 1775 giving way in the last hour. A short, late rally pushed it back over the 1775 October closing high which is the next real definitive support level. It is not a stonewall, however, and a quick ride down memory lane could put the index back near 1700 if buyers remain on strike. Until Tuesday, that is essentially what the selling was: no increase in sellers, just a lack of buyers. There was not a lot of damage in the big names today after Tuesday's whipping as the heavy selling quickly abated. The overall pattern is still hideous, in the continuing downtrend from January. The recovery back over support and the lack of carnage suggests a relief bounce, but there is not a lot to drive it higher for long. Dell's earnings affirmation is a start, but to calm earnings fears there needs to be real earnings surprises, and the meat of earnings are still a week away. Thus any rally may not have fuel to keep it going.

Dow/NYSE

The January closing high broke today as the Dow sold on rising NYSE volume. It managed to buck up at the 50 day MVA and try to return to its trading range, but it fell slightly short. Still very similar to the other indexes, closing near a breach of support after a steady 2 week downtrend from the top of the trading range. It is due for a bounce or a full breakdown. Volume does not support the latter.

Stats: -115.42 (-1.1%) to close at 10,198.29.
NYSE Volume: 1.198 billion (1%). Volume edged higher for the second straight selling session, making 2 straight distribution sessions in a row and three out of the last nine sessions. The volume has been very weak upside and downside.

Up volume: 262 million (-130 million)
Down volume: 941 million (+187 million). Unlike the Nasdaq, NYSE sellers gained strength as even more buyers left.

A/D and Hi/Lo: NYSE decliners jumped to 1.71 to 1 (1.10 to 1 Tuesday) in the first real sign of aggressive selling on the NYSE. The cyclical stocks that had been leading were being sold somewhat today on the analyst economic valuation downgrades.

New highs: 89 (-61)
New lows: 34 (-20). Interesting action. After new lows moved over 50 Tuesday, the start of a potentially negative trend, they turned right back down.

The Chart: http://www.investmenthouse.com/cd/$indu.html

Broke below the January closing high (10,259.74), testing the simple 50 day MVA (10,141.43) on the low and then rebounding. Still below that key level even with the recovery. Volume rose and as seen in the upside/downside volume, that is a sign that sellers were increasing in strength. It could easily test down to 10,000 where the 200 day MVA is residing (9970.45). Unlike the Nasdaq, the overall pattern is not a breakdown; a technical level was breached but not a breakdown. Again, we could see the undercut shake out some sellers and then allow a rebound.

S&P 500:

Broke down further on the NYSE rising volume, undercutting the simple 50 day MVA (1127.75). It hit 1119.68 on the low and then recovered to close right at 1125, a support level from prior price highs and lows in late 2001 and early 2002. This level also marks the middle of the short double bottom pattern in February, a point the index needs to hold or otherwise risk downside to 1100 and then the bottom of that double bottom at 1075. With the bigger cyclical stocks under pressure today, the S&P had as hard a time as the Nasdaq had Tuesday with the downgrades of the big name technology stocks.

Stats: -11.36 (-1.0%) to close at 1125.40.
Volume: NYSE volume rose again, but by just 1% to 1.198 billion shares. Still below average.

The Chart: http://www.investmenthouse.com/cd/$spx.html

TOMORROW

No big economic news out Thursday other than weekly jobless claims. The after hours Wednesday was dominated by BMY clarifying its earlier earnings warning to reflect a serious loss and DELL affirming its earnings and raising its revenue guidance. After that there was competition among less well-known names with warnings in software and upside guidance and earnings in retail and other areas.

That news had the QQQ up 0.50 from its close and other tech stocks showing modest improvement. Enough to overcome the current general worry about the price of oil and the certainty of economic recovery? Probably not, at least not by itself. As noted earlier, investors want hard numbers, proof so to speak that all the reports of economic recovery are more than reports. They will be disappointed with some and pleasantly surprised with others.

For tomorrow we are going to be patient. The breach of significant support and recovery to those levels has to be resolved. We prefer to play established trends, solid patterns within those trends, and changing trends. This pullback over the past month has not altered a lot of trends that are in place. There are trends showing lots of volatility, a sign of change, but we want to see the clean breakdown, i.e., a test of the break and renewed selling for downside positions.

Remember, there has been almost three weeks of selling that basically tested the breakouts by the Dow and S&P in early March. Volume has only once been above average on the NYSE during that time. This may be all the selling there is. What we want to do is see whether the breakout from early March holds and thus maintains that upside bias or is really broken and fails a test, indicating the trend is now down. Many stocks are still in there patterns and in uptrends though we are seeing more breakouts turn and immediately sell, something that was not happening much over the past 1.5 months. That is a bearish sign, but again, we will want to key off the major trends, and we will get an answer on that in the not too distant future with actual earnings reports coming out.

End Part 1 of 2

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