Tech Stocks Lose Immunity Challenge

Whew! That was a brutal week! Napster was given the ax, the Techs are in another bear correction and Dr. Sean continued using his alphabetical voting system to unwittingly help the alliance against the remnants of Pagong.

The coming week may be better. Napster has been granted a reprieve and the techs are due for a bounce. As for Sean, it will be interesting to see if he can survive the tribal council until he eventually votes himself off of the island.

But I suppose we should focus on stocks. Ok then. Yes, it was a bad week for the Nasdaq. Down 10.5% over five days, the index is again in an official correction. The Dow slipped also, but at minus 2% for the week, it's obvious that the damage occurred mainly in the tech component.

The headlines this week have been saying that the selling has been due to earnings problems. That's true, but only 9 percent of the companies that have reported so far have missed estimates. Problem is, some of them are big names and that has really shaken the faith of tech investors.

Can we fully blame the selling on earnings or on mixed signals from economic reports? Not really. It's seasonality and a generally overextended market that caused us to move lower. Technology is typically weak during mid to late summer. Consider the semiconductors. They have been moving sharply lower, yet the earnings trouble has not been occurring in that group.

So Friday the Semiconductors posted slight gains again. That could mean that the Nasdaq has found a temporary bottom. We could see the techs bounce higher early in the week, but the "feel" of this market right now is that a bounce will be short lived and likely to be a bull trap. It may take some time to repair the chart damage from Friday's break below support before an uptrend can once again be established.

After a quick look at Friday's action we'll come back to next week.

Friday's Market:

Tech stocks never had a chance Friday. The sector was already shaken on earnings trouble (most recently Nokia) and the Gross Domestic Product (GDP) report did nothing to ease concerns. At 5.2%, Friday's report was well above estimates of 3.7%, indicating that the economy is still very robust. Interest rates increases may not be a thing of the past after all.

The NASDAQ Composite (COMPX) finished at 3663, off 179 points on the day. Volume was heavy at 1.76 billion shares traded and breadth was very negative at 28 losers to every 11 winners.

The Dow Industrials fell 75 points to close at 10511, which is a key support area. Volume was moderate at 979 million shares and declining issues beat advancers by 2 to 1.

The S&P 500 (SPX) suffered a 30 point loss to close at 1420, just up the road from its 260 day moving average (1 trading-day year) at 1400. The SPX has dipped slightly below the moving average several times this year, but usually has quickly rebounded above it.

On the broad scale, the Russell 2000 shed 11 points to close at 490, a 2.27% loss.

The strong GDP numbers shook treasuries and prices fell. The 10-year note was off 6/32 to yield 6.03% and the 30-year bond lost 2/32 to yield 5.78%. Yields have formed a base at current levels for about a month, indicating that many still believe that interest rates should stay steady.

Sector and Stock Moves:

Recently I've been leading off with the Semiconductors because they are driving the market. Even non-tech sectors, like drugs, are affected by semi's because when chips are falling, the money flows out of techs. So here I go again.

Semiconductors may see some buying interest now. Friday they actually posted a small gain, which was lead by Rambus (RMBS) +4.25. From a risk/reward standpoint, most short sellers would want to consider covering soon, because the SOX index has limited downside with as much as 25% upside.

Software stocks are an interesting study. Microsoft (MSFT) gained 0.31 points Friday after an upgrade from CIBC World Markets, which followed their Thursday analyst meeting. Other software stocks failed to follow Mr. Softee's lead however. The Software sector, which formerly was measured by the CBOE software index (CWX), has ceased options trading so from now on we'll measure it on the GSTI software index (GSO). The index slipped below 400 Friday in a 4.2% loss. Next support is near 380.

Drug stocks have established some support on the Pharmaceutical index near 385 but are range bound at 400. Recent strength is probably due to weakness in techs however. If the techs really do go into a long-term downtrend, the drugs may be able to break into new territory, otherwise the sector is in a negative pattern due to the spread double top formed by highs in April 1999 and in early July 2000.

Networking (NWX) stocks were setting records just last week, now they are off 12.8% from the highs. Almost half of that slide occurred Friday with a 5.48% loss. The reason: Nortel Networks (NT) -4.88 announced that they would acquire Alteon Websystems (ATON) -14.00 in a deal valued at $7.8 billion in common stock. Given the weighting of NT and Lucent in this sector, it's surprising that the recent trouble in both companies hasn't hurt the index worse than it has.

Friday was most unkind to Biotechs, the largest percentage loser of the day, down 6.48%. Human Genome Sciences (HGSI) -10.62 set the pace to the downside after reporting earnings that beat estimates by 2 cents per share. Just another example of buy the rumor, sell the fact.

Financial stocks, ripe for some slowdown Friday, were pulled back by the strong GDP numbers. Two sectors, Brokerages (XBD) and Insurance (IUX) are both currently toying with new highs and appear to be a bit overextended. Some profit taking may occur if more economic worries hit the market.

Monday and the Coming Week:

It will be another full week of earnings, but the big tech names are mostly absent. On the schedule are Global Crossing (GBLX), Globespan (GSPN) and Sapient (SAPE) Tuesday after the close. Digex (DIGX) is Wednesday before the market. Amkor (AMKR) is late Wednesday and Emulex is Thursday after the close.

Economic reports will be highlighted this week with a full schedule. Monday is the Chicago PMI. Tuesday are Personal Income spending, Auto Sales and new Construction Spending. Wednesday are New Home Sales, Leading Indicators, Initial Jobless Claims and Factory Orders. Friday are the biggies: Nonfarm Payrolls increases and the Unemployment Rate reports are due in, estimated at 70,000 new and 4.0% respectively.

Getting back to the charts, the NASDAQ Composite is resting near the 260-day moving average, which is at 3612. A move just below that level to 3583 would fill that pesky gap that was left in the chart dating back to June 1st. Next stop after that is 3500. On the upside, a move back to the 3900 area would probably be met with resistance and new short selling.

The INDU is near a key support area, held up by trendline, psychological support at 10500 and strength in Financials and Drugs. If sector rotation continues, we could see a range bound market topped out at 10850. If everything sinks, next support is at 10350.

Bottom line, techs do appear a bit overextended to the downside here and I would not be surprised to see some buying action soon. Swing traders know that the immediate downside is limited so new short positions are more risky at this level. Earnings are a little slower this week so we may see some rebounding in the beaten up sectors. The unknown factor will be the economic reports, so we'll play this conservatively. If we do get a bounce, we are likely to see short covering en masse, but I am skeptical that it can become an extended rally. If you can't watch your stocks closely with these upcoming reports, it may be safer to wait until we move out of the current downtrend.

Oh yea, I almost forgot. I'm picking Richard as this week's newest outcast.

Good Luck!
Steve Pekarek
Editor

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