Smoke, Mirrors and Some Early Fireworks

Friday marked the end of second quarter 2000 but the period's legacy will stay with the market for quite some time. Nearly exact in its timing, a bear market ushered in the quarter with a 350-point Nasdaq selloff on April 3rd. With the worst behind us (we hope) and the FED in adjournment until August, investors are happily looking forward to earnings season but the lessons learned in April should not be forgotten.

That may be wishful thinking though, since the market is often hit with selective memory disorder. After a month of consolidation at the 3900 level, pundits are asking if we are going to get a summer rally. Aren't we in one? Recent gains have not been given back and the COMPX is up 21% from its lows. I think we've been conditioned to expect huge swings from day to day, but this sideways action seems unnerving - it's too much like investing and too little like speculating!

In fact, many of the leading tech groups, including chips and networking stocks, are at or near their all-time highs. To move the COMPX higher from here, one of two things will need to happen. The leading stocks could keep advancing into new price territory. That would pull up the COMPX. The leaders could also pause, while investors begin chasing up the second and third tier names - a strategy that lead to disaster in March.

If the market can advance further, I look for a target at the 4300 level, which is a 62% retracement back to the all-time high. That's 9% higher than Friday's close. In other words, the summer rally may be more than two-thirds complete already.

So we open the book on quarter number three. Number one was completely euphoric; the second was dismal. Will we return to either of those extremes? I'm guessing that most investors are hoping for a huge rally back to the old highs, but for the health of the market I hope we find some middle ground.

As for Friday's window dressing activities, they probably won't heavily influence the outcome of next week. "Window Dressing" is a market peculiarity that would be more accurately described as "smoke and mirrors". W.D. happens when mutual funds shed their losing names and allocate more money to the stocks that performed well during the quarter. The move is entirely cosmetic; mutual funds close out their books at the end of the quarter and they want to show a chunk of money positioned in the stocks that have performed well.

Friday's trading was fascinating however, and all about institutional posturing. The big funds let the market sell off in weakness throughout the day then they stepped in with huge buy orders during the last hour of trading. The NYSE exchange saw half of its total trading volume during the last hour, while the NASDAQ tacked on 700 billion shares in the final 60 minutes.

The INDU finished at 10477, up 50 points on a rebound from the critical support area near 10330. Total NYSE volume was very heavy at 1.4 billion shares traded, while breadth ended in a 15 to 15 deadlock.

The COMPX gained 89 points to close at 3966. Most of that came during the final 45 minutes of the day when the index touched 3900 and was then off to the races. Volume can be considered very heavy by recent standards, at 1.89 billion shares traded. This was a selective rally with advancers narrowly edging declining issues 22 to 18.

On the broader scale, bulls won the day. The S&P 500 advanced 0.84% and the Russell 2000 gained 0.90%.

The technology issues led advancing sectors. The Amex Networking index is at an all-time high on a 2.9% jump, while the Semiconductors posted a 1.1% gain. The best performing group was Retail, up 4%.

The Pharmaceutical index is still on the move, gaining 1.5% to close at 421. The record for the group is 425, posted in April of 1999.

Losers for the day were banks and insurance, each off about -3.5% and oil stocks, -1%.

The treasury market had little conviction Friday. The 10-year bond finished unchanged and yielding 6.03%.

Friday's Market Movers:

The most recent addition to the S&P 500 list, Broadcom (BRCM), proved that it would be a standout in terms of volatility. An early selloff to $192 saw a late bounce to close at $219 - a 27-point swing.

Storage Networks, Friday's IPO du jour, gained 63.25 points after opening for trading at $27. This week saw a resurgence of activity in the IPO market. Even AT&T is talking about a spin-off of their long distance services.

Banking stocks collapsed Friday under renewed fears that the economy is slowing. Consumer spending came in at a 0.2 increase, lower than expected. If the FOMC raises rates, banks suffer. If raising rates slow the economy, more loans will default and again the banks suffer. A 4% decline on the Philadelphia bank index broke support at 750 and next stop may be at 700.

Retail stocks surged without real news. Call it window dressing or bargain hunting, the sector outperformed everything else Friday. Even more surprising was the rally following reported slowing of consumer spending.

The Pharmaceutical index is now only 1% below record highs. Eli Lilly has a lot to do with the most recent surge, but this sector has been moving higher since March, inverse with the tech stocks. I find it more than a little concerning that the drug and food stocks are still advancing while the techs try to maintain their rally. To me, that means that a lot of money believes more strongly in the defensive issues.

Independence Week:

This week has very little in the way of news, which just may be a reason to rally. With almost no earnings scheduled for this week and a holiday stuck in the middle to boot, investors will be looking to next week and a heavy earnings schedule. Following the ol' "buy the rumor, sell the news" logic, this may the week to front run earnings. The market closes at 1:00 ET Monday and no trading will occur Tuesday. FYI- Splittrader.com will update plays Thursday.

On the economic schedule, the significant reports will come Friday, with Payrolls, Unemployment and Hourly earnings.

Technically, I still like the chances for the NASDAQ Composite to stage a rally before settling into the August doldrums. The chart has a bullish bias over the past month. Another attempt at the 100 day moving average is likely. If that breaks, I look for 4300. If the market should move back to support at 3700 or even 3600, I would still be bullish, because we would then be looking at an inverse head and shoulders pattern that could then challenge 4300.

The INDU continues to dig a hole for itself. I do admire its resilience in this ever-tightening trading range. The levels are now 10600 to 10330, then critical support at 10250. I'm hoping that the INDU can maintain some strength because conviction in the NASDAQ Composite does not seem strong enough to "go it alone" without the Dow.

This week, look for light volume Monday, a possible rally after the holiday and a lack of conviction beyond that. One note of caution, the Volatility Index (VIX) closed at 22.26 Friday. When this indicator reaches the low 20s we have often seen profit taking. We may get a pre-earnings rally, but expect it to be temporary because we may be seeing the last of the really good earnings reports this time around. If you are holding large gains in some of the leaders that have run during the past week, consider setting a line in the sand at which you will sell if the stock retraces.

Good Luck!

Steve Pekarek
Editor

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