Who's Right?

So, who is right? Is it the old guard of Wall Street or the new investor making his/her own investment decisions? The old rules or the new reality? The blue chip/blue bloods or the tech oriented young bloods? The old economy versus the new economy? The Fed's influence and desire versus the markets?

At this point in time, I don't think anyone can convincingly state that all or even most of these questions have been answered on a permanent basis. At the same time, it is fairly obvious who is winning certain battles.

On a daily basis going back as long as any of us would care to remember (four months in today's investment environment), we have been subjected to the same warnings from the so-called experts. More or less, these experts have tried to do us a favor by warning us out of the markets due to the perilous situations that confront the uneducated masses. We are not talking traditional bears either, rather, normally bullish strategists from some of the largest firms on the street. In the meantime, the last 4 months have seen some of the greatest gains experienced in the history of the US markets. All an individual has to do is look at the Nasdaq as well as some of the hot sector indices to see the gains incurred in such a short period of time. Sure, over that same period the markets have experienced some of their greatest volatility. One rule of thumb that will probably never change is that with risk comes reward. Score one for the individual.

Makes you wonder whether these guys, the experts, are looking out for themselves or us? Keep in mind that the old game on Wall Street was for the investment houses to take care of the establishment and institutional money. They would buy from individuals selling during panic driven rallies. They would then hold those securities until they were once again able to lure in the individuals over the "new" excitement in the market. At that point, they would then sell into the strength created by the enthusiasm. They would then move to the sidelines, which would drop the market and create another round of panic driven selling. The individual investors were left holding the bag once again. These same people would step back in to buy back the same stock at severely discounted prices. This was a scenario that played out time and again until recently. Investors aren't scaring out of the market as easily anymore, instead opting to incur the volatility and reap the gains that once were the exclusive domain of the big boys. It's easy to see why they complain about day traders and online trading as it has directly cut into their profits. Don't believe this is the case? Ask yourself why a company as well run and respected such as Merrill Lynch would wait until this past December to initiate online trading for their customers. An oversight? No. They hoped that investors would revert to the old game, allowing them to dominate the investment scene and profits as they always had. In this case, score one for the new investor.

Regarding the battle between the old blue bloods of Wall Street and young bloods of the Nasdaq, there isn't one. Let's face it, the cyclicals and old-line value issues of the Dow and the NYSE are undervalued and oversold. There are, in truth, many values out there among these old darlings. The fact of the matter is that investors are like moviegoers, looking for the newest and most exciting stars. Sure, you can get an aging star cheap nowadays, but it doesn't draw fans to the box office.

Technological advances are what make headlines in today's day and age. The media coverage of these changes and advances creates enthusiasm for the companies leading the way in this new world, which translates to buying pressure on the stocks of these companies. An example of this is the recent run up in the biotech sector. The media is captivated by the recent news regarding gene mapping. The reality is that many of the companies leading in this field are bleeding cash, with no hope of becoming profitable for years to come. At the same time, you have pharmaceutical companies like Merck that have plenty of profitable drugs out on the market and who are profitable. Bottom line, no one wants to hear about a profitable company selling aspirin. Instead, they want to hear about a biotech company that is making progress in the development of a treatment against a certain type of cancer or disease. It is not likely that this will always remain the case, as investors will probably eventually realize the value in the blue chips and seek to own them. When that occurs, the Dow and the NYSE will rebound from its current woes. Until then, expect the chasm between the Nasdaq and the Dow to widen. For now, chalk one up for the Nasdaq and the young bloods.

On the question of the old versus the new economy, one must recognize that fundamentally speaking, we work differently now than in the past. Most of us work in offices or automated workplaces of some sort. Fewer and fewer of us work in factories, or produce textiles and durable goods anymore. The reason this is significant is really very simple. In our everyday work, we are exposed to these new technologies; we see the names of the companies producing the newest, fastest or best features and products. We work and communicate better, faster and more efficiently due to the products of these high tech firms. This exposure is a definite influence in our purchasing decisions, including what we invest in. This familiarity provides a level of comfort for investors when deciding where to put their money. In addition to the name and brand familiarity, investors see the products in action, as well as their effects on productivity in the workplace and in their personal lives. They recognize the overvaluations of many of these new and rising stars, but discount the traditional valuation models, instead opting to look towards growth and potential as the measuring stick for the performance of there companies. The battle of the old versus the new economy has been decided. Barring a catastrophe of some sort, our economy will never revert to that of the industrial revolution. No folks, the high tech revolution is here to stay and it effects how we live and work and directly influences our economy. Chalk this one up convincingly to the new economy.

The battle between the Fed and the markets is actually the toughest. In truth, the real battle is between the Fed and inflation. They have certain tools at their disposal to try to keep the economy and the system balanced and in check. The key weapon they yield is the ability to raise lending and interest rates. In fairness to Greenspan and the Fed's, they use rate hikes to try to reign in non-sustainable growth in the economy. To their credit, they have been highly successful to date. Despite their successes, there are signs of inflation and Greenspan has been candid about his desire to see the valuations in the market pull back some, as he sees the wealth created in the market as a driver in the overheating economy.

In the past, rate hikes equated to higher borrowing rates for companies. In turn, this equated to companies spending less on capital improvements and investment, as the cost of borrowing went up. Eventually, this hit the bottom line in the form of less profits. This phenomenon has occurred many times in the history of our economy and is considered part of the business cycle. This time around though, something has changed. Since the first rate hike last year, the markets have been temporarily affected with each hike, only to go on to new highs thereafter. Only now is the Fed starting to see the expected affects of their tightening policy. The problem now is that it is only affecting cyclical and blue chip companies. These companies have traditionally carried large amounts of debt to capitalize their daily and long-term business needs. Investors realize they are the companies most at risk of diminished revenues and profit due to the rate hikes. At the same time, a small percentage of companies on the Nasdaq have high debt-capitalization ratios. Many of these companies carry little or no debt, having capitalized themselves through equity offerings only. Many use their market caps as leverage for acquisitions as well as for capital spending and expenditures. Because they carry less debt and rely less on it to sustain their everyday operations, they are less affected by rising rates.

The bottom line, the Fed's tightening policy is putting pressure primarily on the companies residing on the Dow and the NYSE. This in turn is prompting investors to seek refuge in the Nasdaq tech issues, further propelling those sectors and the index into record territory. This is something no one expected or could have predicted, least of all the Fed. The only certainty regarding the current situation is that the Fed doesn't like it as it negates a large part of their efforts and effectiveness. The other reality is the fact that in this instance, it won't be the Fed or the experts that determine where the market goes from here-this time around it will be up to investors to determine if and when they will pull their money out of the market, and whether they will continue to invest in companies offering potential as opposed to real earnings. Although many experts would chalk this up to investor ignorance, at least one recently came out and said, "investors recognize that many of these tech companies won't be in business in a few years, let alone ever make a profit. Be that as it may, they do recognize the potential and for now see growth rates that far exceed those of the old economy companies. These growth rates easily outpace rising interest rates. On a comparative basis, many of the tech issues insulate them from interest rate worries and handily beat the returns on the blue chips". The clear-cut winner on this one for now is the investor and the Nasdaq.

As for trading on Friday, the Dow gave up another 230.51 points, finishing at 9862.12. This is the first sub 10,000 close for the index since this past April. Overall volume for the day was heavy at almost 1.06 billion shares. Breadth was once again decidedly negative, with decliners beating out advancing issues by a 3:2 margin. Volume on the sell side ruled the day by a near 2:1 margin. 243 companies set new 52-week lows as opposed to 53 companies that managed to set new high marks.

The main drags among the blue chips and index components included AXP -5.25, GE -5, MMM -5.31, HWP -4.88, IBM -4.75 and MSFT -3.44.

The Dow actually started the day with some positive economic news. The revised 4th quarter GDP was released prior to the open. The new number was increased up to 6.9% from 5.8%. The consensus called for an expected revised number of 6.5%. Although the revised number came in indicating stronger than expected GDP growth, which would have been a definite negative in the eyes of the Fed and the markets, the GDP Deflator came in unchanged at 2%. This is a better indicator (on a comparative basis), indicating that the upward revision in the GDP was due to productivity and not prices. In addition, the Existing Homes Sales number for January was released, indicating that the number of existing home sales had dropped by almost 11%. This was the largest decline since early 1995 and a sign that the Fed's actions may finally be having an affect on the economy.

Despite the good news, the index and blue chips in general struggled early, barely managing to achieve positive ground before succumbing to selling pressure that lasted throughout the day. With Friday's close, the index has now experienced 200 plus point drops 4 out of the last 5 Friday's. Since peaking in mid- January, the Dow is now off 16%. For the week, the Dow was down over 3.5%. Year to date, the index is off over 14%.

The real problem for the index at this point is the fact that it has no real support at this time. Worse, investors don't appear ready to step in to prop the index up. The next real level of support sits back between 9750 and 9800. Failure to hold that level almost certainly guarantees a visit to the 9500 level. The fact that investors will have the weekend to contemplate the failure of the Dow to hold 10,000 should ensure a continuation of the selling pressure at the start on Monday.

On a positive front, the index has now declined so far that almost every component would have to be considered "on sale". The old saying goes "anything is a bargain at the right price". Well, the NYSE, and in particular the Dow issues, are now cheap and should start to be considered a bargain at some point. This fact alone should help the index from a psychological standpoint.

As for the Nasdaq, it managed to trade in positive territory for the better part of the morning, but finally succumbed to the selling pressure created by the blue chip sell off in the second half of the day. For the day, the Compx finished down -27.16 at 4590.49. Volume was heavy, with over 1.8 billion shares changing hands. Market breadth finished slightly negative, 22 to 19. Up/down volume was more or less even as 325 companies set new 52- week highs compared to 122 companies setting new 52-week lows.

Despite the negative finish, the index actually set a new intraday high early in trading at 4662.93. The Compx actually appeared as if it would be able to maintain a close above the 4600 level, but broke down in the final 20 minutes of trading. It hit the day's low of 4576 before bouncing strong in the last 5 minutes of trading. For the week, the Compx managed a gain of 4.5%. Year to date, the index is up almost 13%.

The overall session and close are encouraging in that the index maintained its position in the positive ascending channel we have often spoken about recently. That channel continues to point towards an easy challenge of 4750 in the near term. 4600 should still be considered support unless and until you see a severe breakdown to challenge the 4550 level. For now, 4500 looks like a very safe level as it went unchallenged on Friday. Additionally, Friday's action gives us another higher high and higher low, the fourth such day in a row. This is not the sign of a top folks, rather an index in the midst of a very strong rally. At this point, one that seems sustainable for some time to come.

Action in the sector indices was mostly reflective of the overall negative day experienced throughout the market. The S&P 500 finished down 20.07, while the S&P 400 midcaps lost almost 1 percent for the day. Semis came under pressure, reflected by a drop of 31.68 in the SOX. Internets came under pressure as well, with the DOT experiencing a drop of 8.45 points. The one standout was once again the smallcap stocks, with the Russell 2000 adding 2.70 points. That index is now up over 10% for the year.

The sectors experiencing the most difficulty for the day included large cap tech stocks, textiles, financials, PC's, oil service, software, chip equipment, drugs and gold. Sectors that did well in Friday's trading included B2B, cellular, biotech, telephone equipment, autos and aerospace.

On the bond front, the long bond finished lower for the day, giving up 7/32's to close with a yield of 6.15%. Meanwhile, the 10-year note managed a gain of 3/32's to finish with a yield of 6.29%. The 5-year note did even better, gaining 8/32's to close with a yield of 6.44%. The problem with the yield inversion continues to dominate bond trading, with the 2, 5 and 10 year notes yielding better than the 30 year bond. At this point, the 10-year note has become the benchmark among traders.

There is a slew of economic date due out this week that can and probably will influence trading in the bond pits. Personal income numbers are due out on Monday. The consensus calls for an increase of 0.7%, up from 0.3%. On Tuesday, we get the Consumer Confidence number for January. Wednesday is a big day, as the National Association of Purchasing Managers February numbers are released, with expectations of 57% versus 56.3 for the prior period. In addition, we get Construction Spending and New Car sales numbers. Construction spending is expected to remain unchanged, while February Auto sales are expected to decrease to 7.2 million from 7.3 million in January. On Thursday, we get the Initial Claims report for the week ending 2/26. That figure is expected to rise to 280 thousand from 278 thousand. Friday is the day, though, with the release of the February employment numbers. The unemployment rate is expected to come in unchanged at 4%. Non-Farm payrolls are expected to drop to 175 thousand from 387 thousand. Probably the most important indicator will be the Hourly Earnings figure, one of the most highly watched inflation indictors (indicates wage pressure as a result of falling unemployment and a diminished labor pool) by Greenspan and the Fed. The street expects that number to come in indicating a wage rise of 0.2% for February, down from the 0.4% rise in January. In addition, we will see the January Factory Orders released. Expectations call for a drop of -0.5%, compared to an increase of 3.3% in December. This would be another sign that the Fed tightening policy has begun to impact on business growth and development. Of all these numbers, the employment and wage cost numbers are by far the most important. If these numbers come in negative, expect the bond traders to react negatively. In turn, this may cause further pressure on blue chips and a further flight to quality. Whether that flight to quality leads back to the bond, the Nasdaq or both will be the big question.

As for events that might impact the markets this week, the most important is the Robertson Stephens Tech Conference, slated to begin on Monday and run through Thursday. This should help to further highlight tech issues and the Nasdaq.

On the earnings front, a number of companies are set to report. The notables include, Comcast, Daimler Chrysler, Media One, Healtheon/WebMD, ICG Communications, Litton Industries, Tiffany & Co., Net2Phone, Verio, Costco Cos., Staples, PETsMART, PG&E, Sotheby's and Dillard's. Of these, few if any should move the market in either direction considerably. One thing to note at this point in time regarding this earnings season as it winds down. Approximately 95% of the S&P 500 companies have now reported. Among those companies that have already reported, the indication is that earnings have grown by over 21% over the year ago quarter.

As for the week ahead in trading, look to this past week. The Dow continues to stand on a precipice. We have been talking for weeks about the real possibility of a 4 digit Dow. In fact, I first mentioned the real possibility back when the Dow was trading up near 10,800. Well, the unthinkable to many has now come to pass. Despite the correction (some would incorrectly label this a bear market-but we have yet to slip the necessary 20% from the high), nobody is jumping out of a window. This sell off has yet to spook anyone. In reality, most people have ignored what's occurred with the blue chips, instead looking for the next one to two day hot sector in the Nasdaq. I would expect the Dow to selloff hard on Monday, but that may be it. If the index sails through the 9750-9800 level with ease, expect the index to hit 9500 by midweek. On the other hand, stocks on the Dow and blue chips in general are starting to look too cheap to ignore, Fed and inflation fears or not.

Why would we expect traders to step in soon? Traders are creatures of habit. If there is one thing you can count on them to do, it is to sniff out a bargain and to be the first one to do so. At this point, we are once again looking at a game of musical chairs. This time around, you have a situation where traders are lining up to beat each other to the punch by jumping into the market as opposed to jumping out. Now that the Dow has breached 10,000, you can bet they are all getting anxious.

One other indicator to watch (and that traders are watching) is the volatility index (VIX) that we often talk about. Once again, the indicator is over 29, indicating an oversold situation in the market. It went above 30 earlier this past week and then pulled back sharply when the Dow rallied early in the week. As we have told you before, this indicator has failed to remain over 30 for more than a couple days at any one time. Unlike overbought situations that can remain in effect for long periods of time, traders rarely let an oversold situation go on for very long. A selloff on Monday morning is sure to push the reading above 30, which may very well start the countdown for what turns out to be a serious bounce for blue chips and the Dow.

As for the Nasdaq, the old song "Don't cry for me Argentina" comes to mind. This index needs nobody's sympathy or well wishes. It is doing quite well. It will probably continue to do quite well for the foreseeable future. As we stated earlier, the trend looks good and the money continues to flow into the techs. As long as that remains the case, don't spend your savings shorting this market, especially the bio and high tech issues. What you should do is be selective. Traders are moving their money around at record pace. Today's hot sector is tomorrows or the next day's loser. The money is cycling so fast that the average investor risks getting caught coming and going, paying too much only to see the sector drop almost immediately thereafter. While this type of market can burn an investor, it leaves the door open for some tremendous trading opportunities. Plan your trades to take advantage of this while it lasts, but be ready to make moves and decisions fast.

Good luck!

Louis Horkan
-Chief Editor