Market Indices Defer to the Bears

The market took a wild ride today, probably doing a pretty decent job of faking out investors at every turn. But, as has been the trend lately, when the flurry of trading activity ceased, the major indices found themselves closing lower than the day before.

The Dow Jones Industrial Average (INDU) finished the day at 10,413.79, 110 points lower than yesterday's close. Volume was heavy on the NYSE with 1.38 billion shares changing hands today. Advancing issues trailed declining issues by a substantial margin. 897 stocks gained during the session while 1,981 registered losses. More significantly, 42 stocks found new 52-week highs, among them Exxon-Mobil, while 204 stocks traded at new 52-week lows. The Dow closed off its low of the day that was registered in mid-morning trading. The index traded as high as 10,566 and as low as 10,351, a 215 point range.

The Nasdaq Composite (COMPX) traded off 72 points to close at 3168.49. Volume was heavy at 2.3 billion shares. The selling pressure was heavy, as down volume more than doubled up volume. Advancing issues trailed declining issues by a 28:12 margin. 486 stocks traded at new 52-week lows while only 19 issues managed to find new 52-week highs. The Nasdaq rallied briefly after opening about 80 points lower than yesterday's close. The index then trended down until it hit 3100 and then bounced nicely off of this level. The index rallied into positive territory briefly before again selling off to 3168.

The broader market indices revealed weakness as well. The S&P 500 closed off 22.43 points to close at 1364.59. The Russell 2000 (RUT) joined in the selling, shedding 6.88 points to close at 474.75.

I stress these trading ranges in the Nasdaq and Dow because both indices are nearing substantial technical support levels on the downside. The Nasdaq exhibited a strong bounce off of 3100, but still closed at its lowest point this year. The Nasdaq traded as low as 3042 one day back in May but managed to close much higher that session to 3270. So the Nasdaq, as seen below, is nearing technical and psychological support at the 3100 and 3000 levels. Looking further back to last October, the Nasdaq gapped up on the open to 2919 and never looked back until March. This level would add further support on the downside, should the market break below 3000.

The Dow, while not yet re-testing its March lows, is approaching a level of short-term support established over the past few months. The Dow is also no longer establishing a leadership role, as earnings concerns have taken their toll on old and new economy stocks alike.

The big question on everybody's mind is of course: are we going to get a bounce and a rally into the New Year? Well, as this is a two-part question, let's talk about the possibility of a bounce first. Fundamentally, I don't see a good reason for the Nasdaq to totally break down below the support levels mentioned above. While the growth in earnings in many industries is slowing, it is still positive growth. While there are still questions about inflation, there have been many indicators that the economy is indeed slowing. Specifically, the main ingredient in the recipe for a market crash, namely a recession or a runaway economy, is simply not present.

The level of optimism in the Nasdaq has fallen substantially the past month and few market watchers seem to expect the index to close in positive territory for the year. I believe the most likely scenario is a range bound Nasdaq that cheats to the upside on news and earnings announcements. We think the market will find a floor at or above the support levels we have mentioned. The upcoming slew of earnings could propel the market higher or propagate more range bound activity.

It's no wonder the market has behaved so erratically. There was a lot of excitement today caused by Lucent, Yahoo, and Motorola, just to name a few.

Lucent announced yesterday that earnings would again fall short of expectations. This announcement marks the third time this year that Lucent has pre-announced an earnings warning. The company has been slow to adopt fiber technology as the industry has been moving away its core business of traditional switching equipment. The stock traded off nearly 33% to close at $21.25.

Lucent's announcement carried over to other sectors, as the company also indicated slower growth in its optical business. As Lucent is also a big customer of many other equipment companies, any spending cutbacks by the company could have significant consequences on the rest of the industry.

The market also had to digest Motorola's after market earnings report yesterday. While the company's profits rose 66% and matched expectations, reduced handset growth and slower than expected chip industry growth expectations resulted in investors bidding the stock lower. Motorola traded off 18% to close at 21.46.

The semiconductor industry has been growing on the expectation that demand from communications companies would drive growth for specific kinds of chips. Lower handset growth refutes that expectation. The Philadelphia Semiconductor Index ended the day unchanged at 706.51, but is near some support levels as seen below.

Yahoo also beat expectations but the stock got punished anyway. Yahoo's sales, while above even the highest revenue estimates, still traded off due to fewer advertising customers and revenue growth that failed to double on an annual basis, as the company has done every year since 1996. The stock finished the day at $65.38, almost 21% lower than yesterday's close.

On a more positive note, General Electric (GE) announced that third quarter profits rose 20% on a sales increase of 18%. The world's largest company cited increased productivity gains related to electronic commerce as well as strength across all business lines. Expectations are still positive going forward as the company is slowly transitioning into a service based company rather than a strictly product oriented company.

Earnings related news will continue to drive the market this week. Some positive earnings reports could provide some much needed concrete proof that companies are still making money. The market has adopted a "show-me" attitude and is unwilling to run stocks up ahead of earnings, as we have seen earlier this year. Today's Advanced Micro Devices (AMD) and Applied Micro Circuits (AMCC) reports after the bell could provide such a catalyst. Both companies beat analyst estimates, but as we have seen in Motorola and Yahoo, other factors such as revenue growth and expected shipments could determine the trading direction of the stocks.

The bond market wasn't as big a beneficiary of todays sell-off as one might have expected. A steady supply of new offerings has kept demand for safety pretty well satiated. Bonds traded largely flat today with the 30 year and 10 year issues maintaining yesterday's yields of 5.83% and 5.77% respectively.

Investors have adopted quite a pessimistic attitude of late, unwilling to even reward companies that announce good news. However, investor sentiment is typically used as a contrarian indicator. For instance, the Volatility Index (VIX) closed at 30.95 today. The Volatility Index measures the amount of risk investors are pricing into their options contracts of the OEX 100. More apprehensive investors tend to price in more risk in option premiums. The last time the index was above 30 was back in April and May when the market found its most recent bottom and began trending higher.

So investor sentiment combined with the significant support levels we have identified could suggest a market bottom isn't too far away. So pay attention to earnings and wait for some real catalysts to emerge before wading back into the market.

Good luck and trade wisely.

Chris Pikul, CFA
Assistant Editor

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