Blue Chips All the Rage

Fashions change awfully fast in the stock market. Over the past week the Dow surged, leaving the NASDAQ behind as smart money plowed money into blue chips and shied away from Technology. Now in vogue is the button-up world of old economy stocks, with many of the traditional names back in favor and setting new trends.

Day to day investor sentiment is fickle, but seasonal trends are usually predictable. Not this year. This is an unusual time for the Dow to be breaking out of a trading range. Then again, these are unusual times.

Lately I have been touching on the theme that August is generally a down time for the markets. Rather than blather on about it, I decided to actually support my argument (it lends itself to credibility) with a couple of quick graphs:

So, you can see that over the 11-year period, (I didn't have info readily available beyond that - so much for credibility) the mean performance for August is the worst among all months for both the NASDAQ (COMPX) and the Dow (INDU). So far, the NASDAQ is falling in line with expectations, but how about that Dow? It's up 4.8% since July 31st and up 9 out of 10 days this month!

There has been much speculation about the performance of the DOW. The blue chips have been out of favor for so long that they seem to be a buy, now that interest rates are leveling off.

While many analysts have focused on the possibility of a slowing economy and what that means for each industry, the fact is a slowing economy would affect ALL industries. Leaving that variable static, then you are left with stock valuations. Blue chips have been undervalued; technology has been overvalued. We are currently seeing an adjustment period while each sector searches out an acceptable trading area and then maybe these indices can begin to move in tandem once again.

Assuming that the trading ranges can be established during August and September, history does indicate that we are likely to see the usual fall rally with November, December and January being the strongest period of the year. Of course, that assumes a "normal" year, so here's my disclaimer:

Past performance is not an indication of future results. The information herein is obtained from sources considered reliable but it is not guaranteed!

Ok, that's about as long term as I want to get right now. As for next week, I'll revisit both indices after we wrap up Friday's action.

Friday's Market:

Blue chips surged after the Retail Sales report came in strong at a 0.7% increase vs. expectations of 0.4%. The Producer Price Index remained flat at a 0% increase vs. expectations of 0.1%.

Investors interpreted the report as an indication that the Fed may have engineered the soft landing they had hoped for, as opposed to sending us from expansion straight into recession as some had feared.

As a result, the INDU gained 119 points to close at 11027, the best close since April 25th. Volume on the NYSE exchange was a little suspect because it was light, at 839 million shares traded. If volume was weak, the advance/decline line made up for it, because winning issues trounced losers by a 20 to 9 ratio. For the week, the INDU gained 352 points or 3.3%.

Reaction to the economic news was muted in the NASDAQ cyberspace. The COMPX gained 29 points to close at 3789. Early action saw strong selling that was negative by 73 points within the first hour. A reversal emerged when traders realized that previous selling was technically oriented and the strong performance of the INDU influenced bullishness among tech traders. Volume came in at a moderate 1.3 billion shares (remember it's August) and Advancers lead decliners 2114 to 1777. For the week, the COMPX gained only 2 points.

As for the S&P 500, the index gained 11.6 points, closing at 1472.

Bond traders, being a little more grounded by nature, weren't nearly as jubilant as equity traders. They interpreted the two economic reports as sending a mixed message and of course negative news outweighs positive. Bond prices sagged and the ten year note was off 6/32 to yield 5.78%.

Stock and Sector News:

The week belonged to the commodity-based stocks, with Tobacco stocks (TOB) up 11.3%, Forest Paper and Products (FPP) up 6%, Chemicals (CEX) up 6.1% and Oil Services up 4.6%. One notable sector that crashed this week was the Pharmaceutical (DRG) index, off 4.4% after investors exited drugs on patent expiration concerns, brought to the forefront by Eli Lilly's (LLY) patent on Prozac.

As for the Technology stocks, earnings from Dell Computer (DELL) drove Friday's action. The Company reported earnings that beat estimates by a penny, but officials guided estimates lower for next quarter. This is becoming a concern, because the Tech sector is watching revenue growth very closely and valuations are predicated upon sales. The net result of the report saw DELL lose 4.06 points to close at $37.62. Other hardware stocks took a hit also, including Hewlett Packard (HWP) which lost 2.25 points. HWP will report next week.

In other earnings news, Credence Systems (CMOS) reported and beat estimates by a whopping 14 cents per share. For their efforts, the stock gained only 1.54 points. The Company is in the chip equipment business and as such, is being held down by current bearishness in the Semiconductor index, which actually gained 1.2% Friday. Since CMOS has a TTM P/E of only 32, the stock has a relatively low valuation and could be a compelling buy.

The Coming Week:

Earnings from Hewlett Packard (HWP) will be reported Wednesday evening, in addition to other less important names including NTAP Monday after the bell, HD and TGT Tuesday before the open and ADI after the bell Tuesday. Wednesday are BRCD, CFLO and NOVL after the close. Thursday before the open is CIEN and after the market is Agilent (A).

Other events include a LinuxWorld Conference on August 15th and the Siebel ebusiness 2000 conference also on the 15th.

Economic events will include Industrial Production on Tuesday, CPI and Housing Starts Wednesday and Trade Balance will be reported on Friday. These are the last set of numbers in advance of the Tuesday, August 22nd FOMC meeting.

Moving to the charts, the COMPX is struggling to stay above the 252 day moving average but is mired below the 200-day, which has the index stuck in a tight trading range. Given the lack of impetus for an extended rally, our best hope is to stay in a trading range, but over the intermediate term, the chart is looking somewhat bearish with a retest of 3500 over the next couple of weeks likely. On the upside, our resistance is still 3900 to 4000.

The INDU has found some legs recently. Question is, do we stop and consolidate now that the index is over 11000 or just keep on running? The INDU has managed to break out of the large ascending triangle formation and the next goal is to break out of the diamond formation that can be seen on a weekly chart. Short term, we are likely to see some trepidation around these formations, but long term if we can break above 11200 and stay there, it will bode well for a fall rally.

As for this week and leading up into the FOMC meeting, we might look to other periods in a pre-FOMC week. Often times, we've seen the Indices sell off in the week before the meeting, with a rally in the day or two leading up to and including the meeting. If that scenario holds this time, we might see some holdover bullishness from Friday's action going into Monday and Tuesday, with possible weakness for the remainder of the week, then strength again next week. If I'm wrong, then look mainly for the trading ranges to hold on the COMPX. If support at 3500 breaks, all bets are off. If you are a short-term (2 to 3 days) trader, you may want to stay on the sidelines until the meeting date approaches or wait for a good entry point on a bounce off of support.

Good Luck!
Steve Pekarek
Editor