Apple Flambé

The disaster du semaine (du mois, for that matter) was desktop maker Apple Computer. The Technicolor computer giant disappointed big time Thursday, and did so with a viciousness that only Iridium and Microstrategy (MSTR) investors could appreciate.

For the uninitiated, the computer industry's version of beta gave an earnings prognostication that every nosebleed P/E ratio investor dreads - one that falls short of the consensus. According to Apple head honcho Steve Jobs, earnings will be in the $0.30 to $0.33 per share range, which is a good deal less than the $0.45 per share average forecast of analysts polled by First Call. Jobs explained that sales were slow worldwide in September, which is troubling considering September is usually strong month for computer sales.

For old-time Apple shareholders, it must have seemed like the good old days in the early 1990s when ex-Pepsi executive John Scully ran the show - back when downward earnings revisions were as common as an Al Gore resume embellishment.

Needless to say, investors, who are already dyspeptic from digesting a cornucopia of earnings disappointments over the past two weeks, weren't particularly sympathetic to Apple's plight. The company's stock plunged $27.75, or 52 percent, to $25.75, erasing $9 billion in market value. What's more, it wasn't the little guy disgorging his shares; it was the institutional folks. More than 132 million Apple shares traded on Friday, the eighth-busiest day ever for a U.S. stock.

Unfortunately for other desktop investors, Apple's downdraft didn't take place in a vacuum; most of the company's rivals were sucked down with it. Dell (DELL) dropped $2.63 to $30.81, Gateway (GTW) tumbled $9.13 to $46.75, IBM (IBM) fell $5.44 to 112.50, Compaq (CPQ) dumped $3.09 to $27.58 and Hewlett-Packard (HWP) dropped $9.88 to $97.00.

Naturally, no analyst worth his salt could watch this spectacle go by without giving a thumbs-down. In a classic display of "close the gate after the horses have bolted" mentality, several of them lowered their ratings on Apple and many of its competitors. According to Bloomberg, Andrew Neff of Bear, Stearns cut Apple, Gateway, Dell, Compaq and Hewlett- Packard. Gillian Munson of MS Dean Witter cut his ratings on Apple and Gateway. And not wanting to be left out in the cold, Donald Young of PaineWebber and Steven Fortuna of Merrill Lynch cut their rating on Apple.

With so many desktop computer makers circling the drain, no one should be surprised that all the major market indices finished the week deeply in the red (again) on Friday. Hemorrhaging the most was the tech-heavy Nasdaq Composite Index (COMPX), which gapped down 30 points at the open, and then continued to gap down for the remainder of the session. When it was over, the COMPX had sliced 105.50 points, or 2.79 percent, off its value to close at 3672.82. For the week, the index sliced 131.1 points.

The Dow Jones Industrial Average (INDU) faired slightly better, but not much. The older and less volatile market barometer stumbled out of the gate and kept on stumbling through most of the morning session, losing over 100 points. However, by noon the INDU gained its footing and reclaimed nearly 75 points before the bottom fell out in the last hour of trading. For the day, the INDU finished off 173.14 points, or 1.60 percent, to 10,650.92. For the week, the average finished off 196 points, which isn't bad considering the Apple-like blowout in Eastman Kodak (EK) on Tuesday.

As for the broader and smaller markets, the broad-based S&P 500 (SPX) closed off 21.78, or 1.49 percent, to 1,436.51 on Friday, marking the seventh time in the last eight tries the SPX has finish in negative territory. Meanwhile, the small- cap Russell 2000 Index (RUT) tumbled at the open but managed to claw its way back to positive territory in late trading before slipping back into the red at the close. The RUT closed Friday's session off 2.44 points, or 0.47 percent, to 521.37. For the week, the index was relatively flat, losing only 2.54 points.

As for market internals on Friday, volume was heavy at 1.13 billion on the NYSE and at 1.99 billion on the Nasdaq. Breadth was mixed, with winners outpacing losers by a 15 to 14 margin on the NYSE and losers beating winners by a 22 to 19 margin on the Nasdaq. The session was relatively volatile, as many fund managers engaged in some quarter-ending window dressing, which likely exacerbated the fall in stocks suffering from poor performances this month, such as Apple, Intel (INTC), Kodak and Lexmark (LXK).

Few investors will be sorry to see September end. The month has been particularly brutal to tech stocks. The COMPX lost 12 percent of its value in its worst September outing ever. The INDU and SPX, on the other hand, put on a more respectable showing, shedding only 5.0 and 5.3 percent of their value, respectively.

The numbers look a little more tolerable when smoothed over three months. For the quarter, the COMPX finished off 7.4 percent and now sits 27 percent below its March 10 high of 5,132. Meanwhile, the SPX fell 1.12 percent during the quarter and is down 5.8 percent from its high. The improved performance of many old-economy stocks, such as the financials and oils, enabled the INDU to post a 1.9 percent gain. However, the INDU remains 9.2 percent off its January 14 peak.

Still, if the clock were to stop today, it would be the worst year for U.S. stocks since 1990.

Don't look for third quarter earnings to do much to raise investors' spirits. According to First Call/Thomas Financial, SPX companies will report average profit growth of only 16 percent in the quarter, compared to a consensus estimate of 18.1 back on July 1. What's more, the pace of disappointing earnings forecasts (a la Intel and Apple) is above last quarter's. According to First Call, 399 companies have given forecasts for third-quarter results, of which 64 percent have been negative. At the same point in the second quarter, 57 percent had issued negative forecasts. So all those optimistic folks looking at the glass as half full might want to start looking at the glass as half empty.

Bearing the burden for much of the slowdown in corporate earnings growth is Europe's goofy new currency, the euro, which has enjoyed something of a renaissance over the past week. Since Thursday, the Monopoly-like money has gained 2.5 percent against the U.S. dollar thanks to some slight-of-hand machinations by the Federal Reserve, European Central Bank and Bank of Japan.

I doubt the rally will last, and for that matter I'm not entirely sure the Euro will last. Try as Europeans might to turn their collective homelands into the United States of the Old World, it's just not going to happen. For one, there is no single overriding culture in Europe like there is in the U.S. Moreover, Europeans are too ingrained with ethnocentrism, taxes, socialism and regulation to lift their continent to the same economic plane as the U.S. The fact they address these issues with a new currency demonstrates how just woefully clueless they are to economic realities.

Speaking of economics (though not necessarily realities), we have a few important economic data sets scheduled for release this week. On Monday, the National Association of Purchasing Managers (NAPM) Index will be released. The market consensus says the NAPM index will have risen to 50.0 for September, up slightly from 49.5 in August. The prices paid index, a measure of prices manufacturers pay for raw goods, and a component of the NAPM index, is expected to have risen to 60.0 for the month, up from 56.2 in August thanks in no small part to the recent surge in oil prices.

Then on Wednesday, the Federal Reserve will give us yet another decision on short-term interest rates. The consensus is nearly unanimous that the Fed will stand pat on interest rates, as its past six interest rate hikes since June 1999 have taken some of the steam out of the nation's still- expanding economy.

Frankly, I think we bestow too much significance to the constant barrage of economic data sets, particularly in light of the Bureau of Labor Statistics admission it has understated inflation by 0.1% to 0.3% during the latest 12 months. One can only wonder how accurate other government economic datasets are. After all, when you're not exposed to the rigors of market forces, what is the incentive to get it right every time?

On the earnings front, corporate earnings estimates and actual announcements should continue to guide the market this week (as they do every week). Companies scheduled to report this week that could have an impact on trading include Walgreen's (WAG), Pepsi (PEP) Micron (MU) and Alcoa (AA).

As for trading the market this week, most market participants will be keeping a close watch on the outcome of the Federal Reserve's policy meeting, despite a nearly unanimous consensus that the Fed will take no further action for the balance of the year. So I would expect a flat market for most of Monday and Tuesday.

Then, once the Fed announces it will leave interest rates alone, I still expect the market to remain flat. It's going to take more than an act (or lack thereof) of the Federal Reserve to jumpstart this market. Investors and traders are just flat-out skeptical of the future of many former high- flying leaders. Apple sold for a P/E ratio of 29 before Friday's decline, which isn't all that unreasonable. Now it sells at 15 times earnings. Intel traded at a P/E ratio of 45 before its routing 10 days ago, and now it trades at a market- matching P/E ratio of 25.

At this stage, I really believe that many current high-fliers are vulnerable to a mass exodus, particularly current momentum favorites Corning (GLW), JDS Uniphase (JDSU) and Ciena (CIEN). The fact is all three are much smaller and much more richly valued than either Intel or Apple, yet not one of this terrific trio has a business franchise on par with either Intel or Apple.

Despite my doom and gloom predictions, there is a chance we could have an up week (Let's be honest, statistically there's always a chance of anything happening), at least based on some technical indicators. The Nasdaq appears to have found support at its 50 percent retracement from its July high. If it can hold this level, an advance to 3,800 certainly isn't out of the questions, particularly if the market isn't lobbed any more earnings bombs.

As for the older economy issues, they could find new life this week, too. If the INDU can hold its longer-term trend and immediate support at 10,600, a move to 11,000 seems reasonable. Of course, like the COMPX, the INDU can't be hit with any earnings explosions like it was last week with Eastman Kodak.

With that said, and I know I'm beginning to sound like a broken record folks, but my gut feeling is that this market is going nowhere fast this week, as it has for the past four weeks, so trade accordingly.

S.P. Brown
Editor

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