world stock market, us stock market

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2/17/01 Investment House Daily
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Investment House Daily Subscribers:

TONIGHT:
- Market rocked by news overload.
- Dow, S&P 500 and Nasdaq 100 sell on stronger volume, but outside the big names, the damage was not widespread.
- 'Mixed' economic reports leave investors confused.
- Subscriber Questions
- Team Trades

When in doubt, dump it.

Good news Thursday morning, bad news Thursday evening. PPI higher, consumer confidence lower, home sales higher, 'profit recession' coming, Barton Biggs calling for Nasdaq 1900, and Arms saying bottom has been hit. The U.S. and UK bomb Baghdad. What do you do? Sell now, sort it out later.

News overload led to unloading stocks. The Dow and S&P 500 were handed losses on strong volume. Big names were hit hard as NT warned in October, changed its tune in January, then reneged Thursday evening. Then SGP warned and DELL and HWP reported lackluster earnings and murky waters ahead. Big names were singled out and run out of town. The Nasdaq 100, the biggest tech names, fell 6.7% versus a 5% drop on the Nasdaq overall. The two-thirds of the Dow stocks traded lower. Basically investors were running down and shooting those remaining large names that have not been utterly destroyed already.

As bad as it looked, volume relaxed 10% on the Nasdaq from Thursday's buying session as heavy selling was focused on the big names. This is significant. There was a ton of bad news out there and it was double witching, i.e., expiration of options and futures contracts. The bad news gave every opportunity for the market to sell on higher volume, and expiration cycles usually lead to higher volume. Even with these catalysts, hard selling was narrowly focused on those stocks that continue to bear the brunt of the negative sentiment. Meanwhile, many of the plays we have been tracking continued to hold up well as their bigger brothers were squashed. The fact that volume did not shoot up on the bad news and that many stocks held in their patterns is a positive mired in the ashes of Friday's trading.

THE NEWS THAT HURT: The ECONOMY And Other HEADLINES

If there was confusion before Friday about the state of the economy, there was chaos at the close of the week. Again, CIEN and GX came in with guns blazing about their profit outlook moving forward. NT, the goliath from the north, had to backtrack on its earnings promise, reverting to its posture assumed with its warning in October 2000. Because of its size, NT's warning took precedence over any upbeat reports. As indicated Thursday night, however, we do not believe NT's problems represent the state of business on whole. Much as LU's woes were tied to LU's internal failures (though it first tried to link the trouble to market problems), NT started having problems well before others. Indeed, we have seen GLW (who reiterated forward guidance today), JNPR, AMCC, EXTR and others report impressive earnings and positive guidance looking forward. Something does not smell right in the wind blowing from the north. No doubt the economy is impacting NT's business, but its numbers are not even going to be close to what it just projected. Shades of LU.

PPI shakes up everyone.

Producer prices spiked in January, coming in higher than expected with a 1.1% overall gain and a 0.7% core increase. This is the biggest jump in the overall prices since February 1990 (recession times) and the largest core increase since 1998. The culprits: natural gas shot up 11.6% to inflate the overall number, while cigarettes due to higher taxes and lawsuit settlements, autos due to lapsed incentives, and other more mundane products such as toilet paper. It was pretty broad across the board, and it had one economist after another contradicting each other all day long.

A final 'gift' from the Fed?

Is this the start of inflation, the third 'gift' of the Fed's rate cuts (a tanked stock market and massive economic slowdown being the first two)? In a way, yes. The Fed caused the slowdown in the economy despite Greenspan's ludicrous statements to the contrary in his testimony to the Senate last week. As we have stated on many occasions, the Fed destroyed the supply side of the equation in 2000. In January of that year we predicted the end of rate hikes by summertime and saw signs of the supply side crunch in March. The supply slowdown continued through the summer even as consumer confidence and consumption continued to grow. Confidence did not start peaking until September 2000, but supply was in a downtrend long before then.

It is a fundamental of economics that curtailed supply and increasing consumption leads to inflationary pressure as too much money is chasing too few goods. Note how the overall PPI hit a level not seen since the last recession in 1990. That is no coincidence: recession or economic slowdowns breed inflationary pressures and higher prices as the oldest laws of economics go to work: demand rushes past supply creating inflation. Not until demand cools or supply recovers are these pressure rebalanced. Left alone supply would have met demand; the Fed, however, curtailed supply by increasing the cost of borrowing and drying up investment capital by tanking the stock market. With demand rushing past supply in the second half of 2000, prices were edging higher.

This massive blunder is overlooked by those economists who cling to the historical anomaly described by the Phillip's Curve (way too many members of the FOMC fall in this category). But is it as disastrous as made out to be on the tube Friday? We have to remember that the PPI is much more volatile than the CPI which comes out next week. That will tell us a lot more, especially as far as the Fed is concerned. The Fed realizes that producers were unable to pass prices on to consumers all last year much the same as in 1984 when oil prices spiked higher. If consumer prices do not rise appreciably, the Fed will still feel it has plenty of room to cut rates to try to rally the economy.

Second, the very thing that caused the problem is abating. Consumer confidence crested in September and has been falling ever since. Friday's Michigan Sentiment Survey was the lowest since 1993, indicating that demand has slackened considerably. Still, as we have noted, confidence has not fallen in the gulf as other key indicators such as housing and sales show us. So, it has fallen off levels that will lead to further increases, but it does not appear to have dropped into oblivion. It is imperative, however, that we get real tax cuts, i.e., marginal tax cuts as proposed, to get the supply side back in gear.

Third, commodities prices are not spiking higher. Even with the PPI report and air raids on Baghdad Friday, gold was up, but still is in its downtrend from the $320 level in February 2000 (up $3.10 Friday to 258.95). The commodities index rose throughout 2000, but has recently broken below its 200 day MVA as it appears to be reversing the up trend. These longer term indicators of inflation are showing low and lessening pressure for now, and give further reason not to become too worked up over Friday's PPI.

Still, this whole exercise underscores the need for tax cuts to properly stimulate the economy. The Fed is increasing money supply and that helps demand, but as we are seeing, the supply side is what was hurt the most and needs to be spurred on. That is done with marginal tax rate cuts and capital gains tax cuts. Those paying the most taxes are those who create the most goods and services in our society. To prevent inflation we need to increase supply ahead of demand; we need to get those projects that were killed put back on the table. The way to do that is investment money, and giving excess tax collections back to those who paid them, i.e., those that produce the goods and services insures demand is met and creates jobs where jobs have been lost. In that way all U.S. citizens benefit.

Consumer Confidence takes another hit.

The preliminary University of Michigan Sentiment Survey for February dropped in at 87.8, crashing well below the 94 level expected. Again, this is the worst showing since 1993 and is something to take notice of. Consumers drive the economy, and if they no longer buy, the biggest engine in the economy goes back to idle. That is Greenspan's articulated main concern and that is one reason we have little doubt that the Fed will cut rates by 50 basis points on or before March 20, especially if the stock market continues to flounder. Right now the FFF contract places the probabilities at 100% for a 25 basis point cut and 70% for a 50 basis point cut (at just 35% on Wednesday).

Don't lose hope because of this number. First, just as confidence lagged the downturn in supply, it tends to lag recovery to an extent. In 1991 very few had any notion the economy was recovering based on consumer confidence, but it indeed had started recovering in the first quarter of 1991. Inventories get cleaned out and producers are producing to put more goods on the shelf before consumers are convinced things are okay. It is much like the stock market: the crowd refuses to believe it is time to buy even if the signs are there, and they end up coming to the party late. Second, housing starts and permits continued to increase.

Housing Starts and Building Permits continue to rise.

The major sector that refused to tank even as other indicators corrected sharply has been the housing market. Thursday's survey of builders showed continued strength, and Friday's housing report added more weight to this trend. Housing starts rose 5.3% to 1.651 million annually (1.55 million expected), the third straight monthly rise and the fastest pace since April 2000. Moreover, housing permits hit the highest level in a year. Low interest rates no doubt are helping, and it does not hurt that the bond market rallied today on the concern in equities. That will help keep longer term interest rates from creeping higher.

Industrial Production continues its slide.

Production fell 0.3% versus expectations of holding steady and December's 0.6% drop. It is the fourth month in a row production has declined and the longest stretch since the 1990-1991 recession. It is not a new concept that manufacturing has been in a recession, and we believe that Friday's report is just another factor that will prompt the Fed to make that additional 50 basis point rate cut.

Treasury Secretary O'Neil's 'blunder.'

Speaking to a German newspaper, O'Neil was asked about the U.S.' continued policy toward a strong dollar. O'Neil expressed earlier the Robert Ruben mantra 'a strong dollar is in the interests of the U.S.' When discussing trade O'Neil said that it was a silly idea to weaken currency to improve exports to help pump up an economy. That sounds good. But then he said the U.S. was not "pursuing . . . a policy of a strong dollar. In my opinion, a strong dollar is the result of a strong economy." True, but the rest of the world has been watching closely on the stance of the new administration, and this seemed to be a change from the previous stance. Even with a later Treasury Department statement that the U.S. stance on a strong dollar has not changed, the dollar still lost a cent to the Euro, a major move. The last thing we need is to undermine he dollar right now with a weak economy and a weak stock market. We understand what O'Neil was saying, but the world is too shaky right now for the truth.

The bottom line.

The bottom line is that we are suffering through travails that were completely unnecessary, but were foisted upon a perfectly healthy economy by a Fed chairman who wanted to play prevent defense to protect his legacy and answer to some non-U.S. interests. We have all suffered the past year and have suffered setbacks to financial, educational, and retirement goals and now have to look for a recovery to start putting things back together. That one person could hold so much sway over the lives of U.S. citizens is incredible.

In any event, we have what we have. As we have been saying the past couple of weeks, the economy, while suffering greatly by measure of where it recently was, still has strong, important currents underpinning it. These need to be nurtured or else it could really get bad. Greenspan is focusing on manufacturing, consumer confidence and its corollary, the stock market he helped ruin. Manufacturing continues to gasp, confidence has knifed lower again, and the stock market is hanging on by a thread. We believe these will keep the Fed on rate cut alert, and if there is any worsening in any other indicators we believe the Fed will step in with another rate cut. That is really needed right now as consumer confidence and the market cannot take another plunge.

THE MARKETS

The week was not nearly as bad as Friday made it seem, but a down Friday usually leads to a down start the following week (Tuesday as Monday is Presidents' Day). The market continues to be plagued by warnings in the midst of good news, and it flip-flops from being able to swallow the news to choking on it. The bottom line: the Nasdaq holds at 2400 or it goes to the lows for the year. Problem is, it has few good patterns in the big cap names to lead it higher in the near term. They have been whipsawed back and forth and have built up lots of overhead resistance with each failed run.

But the Nasdaq remains above the down trendline it broke, continues to show good volume on the buying days, and with another quick drop toward the lows it could form a double bottom that shakes out many of the last sellers and allows for a steady, building move. The index continues to show signs of a bottom even though it could test as low as 2000 if really bad new hits in the short term. Enough are saying that will happen to make one believe it won't. On the other hand, Mr. Arms called a bottom today and sent out a special note to customers and clients at 2:30 ET today pronouncing such. Before that Steve Milunovich of Merrill said the big name techs would have an extended period of no movement. There is obviously as many opinions as there are possibilities. As we have discussed before, however, a bottom does not necessarily equal automatic rally. A sideways trading range would not be unusual before it starts back up as the index continues its long base. History tells us that Fed rate cutting will set the bottom in the market barring major economic collapse, and with the 10+ month base it is building, the recovery process looks as if it is taking place to us.

With that in mind we continue to believe the market is forming a bottom here and will be ready to move up when the near term economic signs begin to overwhelmingly show the economy is performing better than expected. Until then we continue to take positions in the strong revenue and earnings generating companies when they dip, play the rolls up and down with covered calls on our longer term positions we are taking, play the new leading stocks that we have on the reports that are in solid businesses, are making money and are holding well. These stocks are moving while the large-cap heavy indexes suffer. These stocks are exhibiting something other stocks are not even as the market struggles. Some of them will go on to lead with huge runs when the market turns.

End Part 1 of 3

world stock market
us stock market