Take a Well-Deserved Rest

If you took a couple of days off at the end of last week, you probably already know that you missed a great rally and some good opportunities. After two days of triple-digit gains on very large volume the market took a bit of a breather today. With October behind us a lot of traders are taking a collective sigh of relief, since October is the month for sell-offs and market lows. This year might be no exception as the Dow hit below 10,000 on October 18, then made an impressive run and broke through some upside resistance, causing most traders to feel better about the outlook for the market in the coming months.

Today was the first trading day with the "new" Dow, which includes Microsoft, Intel, Home Depot, and SBC Communications. The Dow will doubtless have more growth potential with those companies in the index than with Goodyear, Sears, Union Carbide, and Chevron, which are all good companies, but not growth companies.

The "new" Dow's first day of trading was a fairly uneventful one. The markets were mixed with the NASDAQ holding on to narrow gains and the Dow down a little on profit-taking. It is not uncommon to have Monday trading that bucks the trend of the previous week, and most were expecting some kind of pullback after last week's fast and furious buying.

Not a lot of market moving news came across the wires today. This morning's Purchasing Managers Report was benign, reinforcing the interest rate relief from last week. The Purchasing Managers Report is not a heavily followed or even important piece of data, but with interest rates easing a little every piece of anti- inflationary news helps.

The final figures on the Dow show a modest decline of 81.35 points, or .76%, finishing the day at 10,648.51. The big losers in the Dow were American Express and General Electric, down 3.4% and 4.8 % respectively. Intel was also a negative on its first day as part of the index, due to profit taking and another earthquake in Taiwan. This earthquake seems to have hit a more isolated part of the island and will not likely have as much negative impact as the first, but until that is positively shown there will be some concern about it.

The NASDAQ set another record today, actually coming within 3 points of the much-anticipated 3,000 level before tapering off and finishing the day up only 1.22 points, or .04%, at 2,967.65. The S&P 500 finished in the red today dropping 8.81 points, or .65%, to 1354.12.

Market breadth was neutral, which when compared to the breadth of the last several months, can be considered a positive. Advancers edged out decliners on the NYSE 1543 to 1524 and new lows beat new highs 70 to 63. On the NASDAQ decliners won out 1700 to 1592, in spite of the small gains in the Composite. New highs bested new lows by a margin of 197 to 84. Volume was moderate to heavy with 842 million shares changing hands on the Big Board and 1.09 billion on the NASDAQ.

Weakness was very apparent in the financial sector as several Wall Street analysts cut thier ratings on banks and financial firms. The downgrades were based soley on valuations and not on any negative outlooks. By rising over 10% in a matter of days the sector no longer looks undervalued and many analysts feel the sector will need to consolidate for a little while before it can push much higher. The PHLX/KBW Bank index fell 1.21%, but as you can see from the following chart, the sector has had a tremendous rally the past two weeks.

Transportation stocks had a rough day today, with the Dow Transport average falling 2.7% and the AMEX Airline index falling 3.2%, all on a day when United Airlines declared its first substantial dividend in a decade. The decline in transportation stocks was not a result of oil prices, as the AMEX Gas & Oil index fell .47%

Technology stocks again appear to be in the lead as most of them did better than most today. TheStreet.Com Internet index rose another 1.5% and the Semiconductor index gave back only .06% after two days of incredible gains.

The 30-year Treasury bond also took a break from its strong rally last week. The benchmark dropped 10/32, which pushed the yield back up to 6.18%. A week ago today the yield topped at 6.40%, so rebounding about a quarter percent is encouraging to bond traders and those who have been hoping for a rebound in bond prices. After such strong gains last week we will probably see bonds tread water for a few days, looking for some more positive news before the rally can continue.

Looking ahead one must wonder what, if anything will push the markets to new highs. The earnings season is basically over and by and large the results were very good, with only about 11% of stocks coming in below expectations. Most analysts, however, see earnings growth slowing next year and the markets are almost always forward looking, not backward looking. In very few aspects of life do the words "what have you done for me lately" apply better than in financial markets. A stock can be Wall Street's darling one week and a hopeless loser the next. Last quarter's earnings will not make the markets go substantially higher.

Investor sentiment will likely be the number one factor in determining the direction of the market in the coming months. If investors become more comfortable with interest rates and the inflation outlook the market could easily regain its upward momentum going into next year. There is still a considerable amount of cash on the sidelines and if U.S. equities can lure that money in, there is a lot of upside potential. If the Fed does not raise key interest rates by 25 basis points in November, they will probably not do so the rest of the year, and that alone could fuel a sharp rally in stocks. A week ago the consensus was decidedly in favor of another hike, today things do not look so certain.

If, however, the Fed decides to raise rates and we see some more ugly economic reports, like last month's PPI, things will not be so rosy. Just because stocks and bonds rallied last week does not mean anything has fundamentally changed about the economic environment. And with Y2K coming up, it is hard to predict how investors will react to that once- in-a-lifetime occurance. If something happens to again turn investors sour on stocks, we could see another decline and test of support levels around 10,000 one more time this year. Time will tell.

As we have stated several times in our market updates and commentaries, regardless of what is going on, there are always good opportunies, both going long and going short. Stick with the strong sectors and the stocks within those sectors that are the leaders, or the ones best positioned for the future. One thing that does seem certain, however, is that market volatility will probably remain high. Good luck and happy trading.

Chad Poulson
Research Analyst