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Nasdaq went nowhere on Friday. Probably just a bunch of day-traders at work. No evidence of any major buying or selling. It would have been reasonable to expect some significant profit-taking after the Thursday rally, but we didn't see much selling at all.
Further pressure on the market came from the Q3 GDP report, the Chicago PMI report, the Novellus (NVLS) warning, and cautious comments from Lehman Brothers analyst Dan Niles. But, even without any of that, Nasdaq could very well have ended where it did. So, we can say that the market held up very well in the face of all the negative news.
The Preliminary Q3 Gross Domestic Product (GDP) report was a bit worse than expected. This was a negative report. The good news is that this provides a lower starting point for Q4. I still expect Q4 to be a quarter of negative growth because October will have had a dramatic negative impact from the events of 9-11. And from my reading of the Fed Beige Book, at least the first half of November will also show negative growth. We won't get the advance report on Q4 GDP until late January. Part of the decline in Q3 was due to the fact that inventory is counted in the quarter it's produced (say, Q2) and doesn't count in the quarter it is finally sold (say, Q3). The Q3 report showed a significant decline in inventory. The hope for coming quarters is that as so much inventory has been worked off, production will ramp up again.
The Chicago Purchasing Managers Index (PMI) report for November was significantly worse than expected. This was a negative report. The manufacturing sector is still not even close to recovering. But, this report may reflect more on conditions in late October than on the second half of November. Also, some people believe that the Chicago area lags behind the rest of the country.
The Economic Cycle Research Institute (ECRI) Weekly Leading Index (WLI) rose for the second week in a row. This was a positive report. The index is now almost back to the level of September 14. The six-month smoothed growth rate had a trough in the week of October 26 and has trended up since.
Nasdaq has now closed above its 100-day moving average for 14 days straight, and just barely stayed above its 150-day moving average for a second day. 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. The 200-day moving average is less than 25 points above the current level. Within a week we could be above both it and the 2000 level as well.
The CBOE Market Volatility Index (VIX), which measures the level of anxiety in the market, FELL by 1.49% on Friday to 25.87, which is at the lower end of the moderately high anxiety zone (25 to 30). VIX rose a bit on the open and stayed up until about 2:40 p.m. when it began to decline into the close. People were impressed that that the market held up so well despite the ongoing Enron debacle, lousy economic news, and worries that the recovery may be further off than expected. VIX is in really good shape.
The Nasdaq-100 After Hours Indicator kept a negative bias for the entire Friday evening session, closing down 1.81 points. I saw no after-hours news that would account for this drop. Maybe just some rumors going around. A senior executive left Oracle (ORCL), but I wouldn't say that was enough for the decline. Maybe people are just anxious for Nasdaq to do SOMETHING other than just sit here like it's dead in the water.
Fed Funds Futures suggest a 94% (unchanged) chance of a quarter-point cut in interest rates at the December 11 FOMC meeting. The cut is now a virtual certainty. There's also now a 14% chance of a second quarter-point cut at the January meeting.
The "war" in Afghanistan continues to go fairly well. Sometimes it may seem a bit slow or bogged down, but that's just the superficial, external view. The fact that there are a few ground troops in there now (1,000 Marines) should not be a big concern. There simply will not be a major ground deployment there. In fact, U.S. ground forces probably won't even participate in post-war peacekeeping in any significant numbers. The big question now, swirling around Washington is: What about Iraq? The issue is not whether they were involved with 9-11, but whether we need to preemptively eliminate their capability and interest in weapons of mass destruction (nuke, chem, bio). There may still be hope that our efforts in Afghanistan will act to deter Iraq, but there are plenty of hawks in Washington who firmly believe that Iraq's president must be removed from power to effect substantial, lasting change. The policy battles continue to rage in Washington while we're busy in Afghanistan, but a definite course of action against Iraq could crystallize at any moment. I believe that what we can expect is a series of ultimatums directed at Iraq to give them the opportunity to reform themselves. They likely will not, but that refusal will be the justification for any military action. How the market responds will be another story. The initial market response could be a big dip. Buy it, heavily. The market will come back strongly as progress is made against Iraq.
What about the tech IPO market being dried up? Don't worry about it. There are two ways for companies to "cash out". First, the standard IPO. Second, by selling out to another company. For example, Tellabs (TLAB) just agreed to acquire privately-held Ocular Networks for $355 million. There were many hot new tech companies that sold out to Cisco (CSCO), Intel (INTC), Microsoft (MSFT) and other established companies even at the height of the recent IPO mania. That kind of sale is just as important to the process of encouraging innovation and venture capital investment as IPOs.
I see a lot of brokerage downgrades due to price levels. Basically, the brokerage analysts are telling people to lighten up on stocks that zoomed up way too far way too fast. Understand though, that your broker will be obligated to collect commissions from you if you sell. They are not making these downgrades out of the kindness of their hearts. If you're not buying enough stock from them, they have to try to get you to sell instead. Still, these downgrades are good in a way because they keep the market somewhat disciplined. A more gradual rise reduces the chance of a major sell-off.
We're coming up on warning season for Q4. A few companies will bless us with upside surprises. More will just squeak by with already lowered guidance. But a fair number will issue nasty warnings. The market will have to struggle through all this on a daily basis. I don't think anyone had any notions that Q4 was going to be a good quarter or that Q1 would be much better. Novellus (NVLS) may be typical. Their situation was not bad, but the stock had run up a little too fast. But, the drop of Novellus on their warning for Q1 may have been just a knee-jerk reaction and the stock could very well resume climbing again soon as people adjust to the Q1 expectation. The cynical short-sellers love to slam a stock like this whenever they get the chance, but they eventually have to buy back their shorts, especially if normal investors don't take their lead and dump the stock. I don't think the Novellus warning was bad enough to cause any true investors to dump the stock.
I bought some Novellus (NVLS) because the drop on Friday seemed a bit too extreme a reaction to news that should not have been a real surprise. They're a good company and the only problem is that the trough and recovery are just a little bit further out than some had hoped.
There are a lot of people betting that the chip equipment sector will trough sometime in Q4 or Q1. The Novellus warning suggested that the trough could be even further out. But that's still a guess by Novellus. All they really know is that their current orders were down and that means revenue in Q1 will be down. Nobody in the sector has enough visibility right now to predict orders for Q1 or Q2. But, the stock market is supposed to be a barometer (predictor) of future economic activity. That's why stocks rise well in advance of actual earnings reports. If there is a chip equipment trough in Q1 which results in better earnings in Q2, aggressive speculators want to own the hot stocks well before the amateurs buy them based on broker recommendations. Also, the analysts got plenty of egg on their faces by predicting way back in February that the chip equipment trough was going to happen in August. The result of that embarrassment is that now they are being much more conservative. It's always one extreme or the other. Investors can arbitrage this tendency to extremes by betting on the middle. Yes, I'm buying chip stocks, but it's quite a speculative risk. They simply are not safe yet. They won't be safe until at least two of the major players in the sector report an uptick in orders.
Forgive me, but just for amusement, I bought 2,000 shares of Enron (ENE) on Friday at 28 cents a share. It's more for entertainment than an investment. The total amount at risk is very small (less than $600). Even if Enron does somehow survive a bankruptcy reorganization, it would most likely be via an infusion of capital that would likely wipe out all current shareholders. Also, tax-loss selling could continue. And, Enron's credit rating was cut even further late Friday. But, like the New York Lottery, You Never Know. This "investment" is simply a lottery ticket and has absolutely no value unless I "win".
I could have spent that same amount on a new Pocket PC, but I'd end up more frustrated and less entertained. That says a lot about how far handheld computers have to go, at least before they appeal to me. They need larger, higher resolution screens (with scrolling) and Java for full web browsing and support for HTML email. And they need fully-integrated, broadband wireless (3G) support. The big demand for 3G wireless will come not from cell phones, but for handheld internet access. But won't this mean they'll need larger, heavier batteries? Only if we don't have micro-fuel cells. These kinds of devices will also spur demand for much larger flash memory chips (1-10 GB) as an alternative for hard disks. But now I'm already way ahead of the near-term prospects. I looked at the new HP (HWP) and Compaq (CPQ) Pocket PC's and they are a definite improvement, but still not enough to amuse me as much as the Enron debacle.
There could be a fair amount of "window dressing" buying by portfolio managers in December so they can say they're invested in the best stocks. That should include the higher-quality tech stocks, especially those with positive, growing earnings.
The extent to which tax-loss selling will be a significant drag on the market is very uncertain. Certainly, some people will benefit from it. But if someone has a big loss in a hot stock, why would they give up the potential short-term upside? They could double-up and then sell in late December. That would mean they already bought and will sell sometime in the coming four weeks. My best guess is that many people who had a big loss but something of a recovery since September 21 have already dumped their stock or are planning to hold for the coming rally when the economic recovery starts to kick in. Also, given the huge drop in margin debt this year, many people have already sold their stock anyway. Still, the uncertainty remains. What you can be sure of is that everyone will sell at their own particular pace so there won't be a well-defined period clearly defined as tax-loss selling.
Special note on tax-loss selling: you get absolutely no tax benefit by selling stocks for a loss in a retirement account. That said, untold numbers of people may in fact try to do exactly that. This adds insult to injury for all those Enron employees who had lots of their 401(k) money tied up in company stock.
Another big question is the infamous January effect. It's usually a noticeable rally that is the result of people selling for tax-losses in December and then buying back a month later. The start and end of such a rally is never consistent. Sometimes it doesn't happen at all. In 2000, it happened in December of 1999.
I'm not expecting even a single one of the top techs in my Tech Stock "Safe" Index to claim in December that they are seeing a significant improvement in their business. That said, I do expect that a number of the companies will increasingly talk of stabilization, increasing (but still limited) visibility, hints of improvement, renewed customer interest, and other "teasers" that should have the effect of keeping the buying pressure up on the quality tech stocks.
As gloomy as the Q4 preannouncement season may be, this may be a great time for sidelined money to wade a little deeper into the market. But that will only happen to the extent that we incrementally see signs of improvement in the economy on a fairly frequent basis.
Economic recoveries are rarely smooth, straight up affairs. There are always minor setbacks along the way. Last week's rise in Initial Jobless Claims was very disappointing, but we can't let a bad week imply a change in trend. The Fed Beige book was also very disappointing, but despite its utility in describing where the economy is at, it doesn't give any clue of where we're headed. I remain optimistic that we are in fact in the early stages of a recovery. The ECRI Weekly Leading Index is one of my primary guides.
The "game" we're playing now is very well-defined: climbing the wall of worry. That's the way it always is at times like these. For this week, the issue is not whether the news is bad, but how the market responds to bad news. We can't expect every work to be a success, but the overall trend, since September 21, has been up. The coming economic recovery may not be here quite yet, but its arrival is inevitable. If for no other reason, the "war" will force a lot of spending and investment that will assure a recovery.
The big technology event today could well be the unveiling of inventor Dean Kamen's "IT" (code-named Ginger) on Diane Sawyer's morning show.
It's Monday again, so it's time for me to make my latest dollar-cost averaging (DCA) purchase of S&P 500 Tech Sector "Spider" (XLK) LEAP call options.
Many people are worried that the market has come way too far way too fast without a major correction. The reason there hasn't been a major correction is that the level of optimism is so high. Unless there is a significant drop in optimism, the Fall rally will continue with only an occasional small dip. Personally, I believe that Nasdaq gains strength every day just from its ability to trade in a narrow range (like Friday) without zillions of momentum investors bailing out. There's nothing bad about a trading range. It indicates that a solid base is being built that will provide firm support for the really big rally that will come as the economy really does start to show signs of recovery.
The bottom line: The Fall rally (48 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: The trough for the recession was probably the second half of October and the economy has slightly improved since, even if not yet noticeable by economists (they won't have a handle on November until January). As December and January 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: December 02, 2001 11:24:45 PM -0500
Copyright © 2001 John W. Krupansky d/b/a Base Technology