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Should we blame the entire Wednesday decline on Enron (ENE)? Or maybe the Fed Beige Book sounded too gloomy. It was just one of those occasional "off" days where there's just enough bad news to dampen people's spirits and encourage sidelined money to stay put. And with buying weak enough to encourage a touch of short-selling and to encourage momentum traders to bail out and wait for a sunnier day. Even so, there doesn't appear to be anything for investors to worry about.
It's possible that the Enron meltdown inspired some "contagion" selling such as for margin calls. In other words the fall in Enron left some people with such big losses that they had to sell other stocks to cover the losses. There were probably a few people out there who bet the farm that Enron was "cheap" at $5 and bought boatloads on margin. Ouch. Also, since Enron is in the S&P 500, people may have dumped various index funds to avoid the drag from Enron and this dumping would cause all the other stocks in the index funds to experience selling pressure. Enron is also in the S&P 100 which is the index on which the Volatility Index (VIX) is based, so Enron could have caused VIX to rise as well, besides investors dumping S&P 100 futures. Lastly, there may be mutual funds that held Enron and got hit with redemptions which caused the funds to dump other stocks to cover the Enron losses.
The Enron mess was bad enough for the White House and U.S. Treasury to comment on it. Actually, I think it was just them responding to press inquiries. The White House said Treasury was keeping an eye on it and Treasury merely said they had their eye on credit markets and saw nothing out of the ordinary. I saw no comments from the Department of Energy. Later, the Federal Energy Regulatory Commission (FERC) said everything was fine.
Overall, this was one of those days when the market focuses exclusively on the short-term bad apples and pretends that the longer-term sunny orange outlooks don't exist. The Fed Beige book was gloomy, but it speaks mostly about where the economy has been over the past six weeks with few clues about the near-term outlook, let alone the six-month outlook. And Enron was the rottenest apple of them all.
The Federal Reserve Beige Book (Commentary on Current Economic Conditions) did not paint a pretty picture. This was a negative report. In summary, "economic activity generally remained soft in October and the first half of November, with evidence of additional slowing in most regions outweighing signs of recovery in a few districts". Accordingly, I'll have to slightly reduce my short-term optimism about the economy, but just slightly.
The Mortgage Bankers Association (MBA) Mortgage Applications Survey showed less mortgage activity last week. This was a slightly negative report. Refinancings were down, but applications for purchase were up. Mortgage activity is still at a fairly high level.
The weekly Oil and Gas Inventories report showed that plenty of gasoline and heating oil is available, but a little less raw crude is sloshing around. This was a positive report for consumers and businesses (other than the oil companies).
Supplies of Natural Gas are also plentiful, despite the Enron mess.
Nasdaq has now closed above its 100-day moving average for 12 days straight, but just moved back below its 150-day moving average. The 50-day moving average has turned up even further. The 100-day moving average is still declining and will need another week of gains to begin turning up. Traders tested Nasdaq to see if it could be pushed back under the 150-day moving average, and this time they succeeded, but for how long remains to be seen. In particular, if dramatic additional selling does not occur today, traders may reverse and try to run up above the 150-day moving average again.
The CBOE Market Volatility Index (VIX), which measures the level of anxiety in the market, ROSE dramatically by 10.43% on Wednesday to 27.84, which is up in the middle of the moderately high anxiety zone (25 to 30). Part of this was the Fed Beige Book which suggests that the recovery may not have started yet. The rest of it is Enron's fault. Anxiety over any potential contagion effects of the Enron mess clearly caused people to be anxious about the whole market. This also directly affected VIX because VIX is based on futures for the S&P 100 Index futures and Enron is part of that index. But at the end of today, Anheuser-Busch (BUD) will be replacing Enron in the S&P 100, the market should be able to stabilize. But it may take a couple more days to get the bulk of all this Enron mess behind us. In any case, those people who thought VIX was indicating excessive complacency will now be relieved that investors are once again not so complacent. This should make it easier for sidelined money to believe that the market is a little safer.
The Nasdaq-100 After Hours Indicator bounced around in a very chaotic manner for almost the entire Tuesday evening session, but managed to take on a slight positive bias right near the end, closing up 0.64 points. Basically, people were shell-shocked by the whole Enron fiasco and the gloomy Fed Beige Book and very unsure what to do.
NVIDIA (NVDA) will replace Enron (ENE) in the S&P 500 Index after the close of trading on Thursday. And Internet Security Systems (ISSX) will replace NVIDIA in the S&P MidCap 400 Index at the same time.
Altera (ALTR) reaffirmed guidance for the current quarter.
Palm Computing (PALM) reaffirmed guidance and said revenue will be in the upper end of the range. Their quarter ends tomorrow.
Fed Funds Futures suggest a 80% (up from 66%) chance of a quarter-point cut in interest rates at the December 11 FOMC meeting. Futures plus a simple reading of the Fed Beige Book strongly suggest that a cut is an almost a sure thing. In fact, if the fiscal stimulus logjam is not broken before the FOMC meeting, a half-point cut would make sense.
I'm still in a buy-on-dip mode. Seeing Nasdaq down 40 points, it was hard to resist. I bought QUALCOMM (QCOM) and LAM Research (LRCX). These are not trading positions. They are long-term, buy-and-hold positions. I also bought more January 2003 LEAP call options on the Nasdaq-100 Index Tracking Stock "Qubes" (QQQ). These LEAPS are obviously not truly long-term investments, but they're not short-term trading positions either. I could hold them for a few months.
The Enron debacle did not have to happen. Just as with the Long-Term Capital Management (LTCM) meltdown in 1998, the pros on Wall Street saw that a sacred cow was very vulnerable and they attacked. This caused a chain reaction of events. Once the stock and bonds were pushed below a certain level, covenants were violated, ratings were slashed to "junk", and large blocks of debt became due. In the end, somebody will pick up the pieces for a song. Why did it really all happen? Short-sellers and cynics were frustrated by the resilience of the tech stock rally and searched until they found an inviting target that they could focus their energy on. Without the short-sellers, I doubt that the implosion would have occurred. But more importantly, now that Enron is almost done, who's the next target of these vicious dogs? It won't just be overvalued, high-flying stocks, but companies that have some kind of financial vulnerability that will have an Enron-like chain reaction.
There might be some lingering aftershocks from the Enron implosion. But mostly that will be companies that have some exposure to Enron itself and maybe some banks. Plus any mutual funds which had to sell stock due to Enron-inspired redemptions. I don't expect much of this, but you never know. The market might well bounce right back with a modest recovery rally, or we could see another day of consolidation before recovery begins.
A bunch of the S&P indexes (S&P 500, 100, MidCap 400) will change due to Enron falling off the map. These adjustments could case unpredictable volatility in the stocks in those indices, especially since index mutual funds have to adjust to those changes. The net change should be minimal, but while the shuffling is going on, traders may play lots of games.
The market could recover dramatically, or people may get the jitters and we could see a major sell-off. Flip a coin. But if there's a big dip (over 20 points), I'll be buying (something).
The bottom line: The Fall rally (47 days old) is still intact. A modest dip (say, 5%) is to be expected, but any significant dip should be bought.
Short-term economic outlook: According to the November Fed Beige book, the economy was still soft through mid-November. I won't disagree with that, but I still think the trough was in mid-October and the economy has slightly improved since, even if not yet noticeable by the Fed economists. As November and December progress we will gradually start to see more incremental signs that the economy is beginning to recover. Not a large improvement, but at least the trend will not be downward. Some indicators will continue to decline, even as others begin to stabilize and some even begin rising. But, October and the first half of November were probably bad enough that Q4 will "print" as a decline in GDP. Employment will continue to fall until GDP finally breaks above the rate of productivity growth, probably late in Q1 of 2002. The manufacturing sector won't trend up from a trough until sometime in Q1.
My tech stock "safe" signal is still stuck at 0.0 since none of the major tech companies is yet publicly claiming that they have evidence (other than "hope" or "hints") that their business has started to accelerate out of the tech downturn. My "safe" signal requires at least 20% or 1 out of 5 of the top 25 tech companies to signal acceleration. Expect at least two quarters to elapse from the time of the first indications of an upturn and the return of solid growth. The theory is that the stock market should begin a sustainable rally six months in advance of the return of strong growth. Despite recent events, I continue to peg Q2 (May or June) of 2002 as the timeframe for the return of relatively strong growth for the bulk of the tech sector.
Jack Krupansky
Updated: November 28, 2001 11:14:45 PM -0500
Copyright © 2001 John W. Krupansky d/b/a Base Technology