The tale of two stories!

If you ask anyone out there to name the top story on Friday, they are obviously going to pick the release of the PPI report. We agree. The release of those numbers was and is important, so we will start with that story. But, we do feel that another story has been overlooked. One that involves a very important sector known for leading the market. This particular sector generally garners the lions-share of news (along with the Internets) and is made up of some of the leading companies in the world. Their products in some way affect almost every other business in the world, the economies of the world and indeed our daily lives. Any guesses? We'll get back to this soon enough. For now...

Another Friday, another good economic report, another rally. So what else is new? For the second week, government figures showing no evidence of price inflation put investors in a buying mood. In response, the markets surged higher. The Dow reversed the slide that had set in this past Monday, gaining almost 90 points, while the Nasdaq composite (COMPX) added over 26 points. The Fed report (released before the market opened) showed that the Producer Price Index (PPI) rose +0.2 percent in November. That followed a -0.1 percent decline in the index last month. The increase was driven by higher prices for energy related products. More important was the fact that the core component of the index, which strips out food and energy costs, remained unchanged for the month. That component posted a +0.3 percent gain last month. Why is this important? The PPI shows movement in prices paid to the nation's factories, farms and refineries. Keep in mind that the PPI is not considered as relevant an index as the Consumer Price Index (CPI- due out this Tuesday), which measures increases at the personal and retail level. However, most economists view the benign numbers as further evidence that inflation remains in check as the economy moves along into it's longest peacetime expansion ever. The PPI, CPI, employment, productivity and wage costs numbers are a major part of the evidence used by the Fed in deciding interest rate moves. More and more, Fed observers believe that previous Fed actions (rate hikes) have had an affect and that no further tightening will be needed over the next few months. Unfortunately, we will be covering the same ground again on Tuesday (CPI). The release of those numbers may further solidify the above mentioned beliefs. Then again, bad CPI numbers will change the argument and quite possibly steal Christmas from bullish traders. Time will tell!

Now, on to the hidden story. Semiconductors are used in almost every electronic component known to man. They have become a commodity second only to food and water. Maybe a little overdone, but they are important to our everyday lives. The sector stands at or near the top of the food chain in the high tech arena. For quite some time, we have heard just about every analyst on TV come out and tell us that the sector is overextended. In all fairness, they have had valid reason to do so. The semi's (SOX) have led the Nasdaq in a record year, gaining approximately 62%. That is huge by anybody's standard and arguing for a correction would seem justified. Add to the mix the fact that the SOX gained almost 18% from the beginning of Nov though Dec 6th. The argument gets stronger and receives all kinds of news coverage, justifiably.

SOX 3month chart

What is puzzling is the fact that the SOX has slid over 7% in the last 4 days, yet it doesn't seem to be that newsworthy. In fact, we've had consecutive days in which the index slipped anywhere from 3%-6%, yet no one stands to defend the sector. Gaining 62% in a year is newsworthy, but, equally so is any stock, sector or index losing the same amount of ground as has the SOX in such a short period of time. The SOX actually bounced off of very key support on Thursday and Friday. Friday's low, established early in the day around 620, is support first established in early November. Failure to have held that level would have spelled trouble for the entire sector and quite possibly the Nasdaq. The index went on to close at 632.63, right on the 30 dma. More than one trader out there must have realized the significance of the 620 test, because the index bounced off that level fairly quick. This leads us to question "Why would someone grab what appears to be a falling knife", ie.- the overextended semi's. Maybe, just maybe, the buyers recognized a great entry and opportunity to own some of the biggest names in the high tech community at bargain prices. It might even be a safe assumption that someone out there believes that the recent downturn in the sector offers a short-term opportunity for a nice move to the positive side. Having said that, by no means do we think it's time to jump in with both feet. This may be just another stop on a train heading south, in which case the semis should be avoided. At the same time, this is the type of opportunity that the pros look for. When they get them, they take advantage of them, and you can bet they don't advertise what they are doing. When you hear about the newest, hottest, "must own stock or sector", you can bet the pros have already staked out their position. This may one time where you get a chance to stake a claim early on in the game.

On to Friday's internals. The Dow rose 89.91 points, closing at 11,224.70. That allowed the index to recoup some of the weeks earlier sell-offs, but the index still closed down over 61 points for the week. Volume on the Dow was 987 million. Advancing issues led decliners, but only by a narrow margin of 1554 to 1490. Much of the strength of the rally was masked by the disparity in stocks hitting new highs at 87 -vs- new lows weighing in at 131. Leading the way for the Dow were old favorites, like; AXP +7.94, WMT +1, AA +2.50, GE +3.44 and JPM +2.75. As would be expected, techs were weak, with IBM -4.38, INTC -1.00 and MU -3.25. Of note is the Xerox warning that they could miss the numbers by as much as 40%. This was released after the market, so it didn't hit the Dow Friday, but probably will on Monday.

The NASDAQ was more cautious throughout the trading session as tech buyers remained on the sidelines. However, the index shook off earlier sharp losses to close higher by +26.07 points to another record high of 3,620.24. This marks the 51st new record high in 1999 for the COMPX, and the sixth in the last seven sessions. Volume was heavy at 1.6 billion shares, just slightly behind Wednesday's volume record. The advance /decline was close at 23/20. The initial sell-off was fueled by weakness in the tech sector, spurred by IBM's announcement that Year 2000 related spending freezes at many technology companies would hurt earnings reports for the next few quarters.

Oil weighed back into the picture on Friday. The price rise effect on November's PPI report was diminished somewhat by Friday's drop in world crude prices. On the NY Mercantile Exchange, the January crude price fell $0.92 cents to $25.23 a barrel. This was in response to the United Nations Security Council vote to extend the "oil for food deal" with Iraq for another six months.

So who's afraid of inflation now. Every bond trader out there, STILL. Despite this, there were some buyers in the pits Friday. Bond prices finally got the message this week after disregarding news on inflation for the past month. For the first time in five weeks, the yield on the 30-year Treasury actually fell for the week. Friday's action showed the benchmark bond gaining 21/32 of a point, bringing the yield down to 6.16 percent. Bonds gained $0.88 for the week.

Other technology and computer sectors were also weak. The aforementioned semiconductor group was lower across the board, led down by Advanced Materials, which lost -3.25 to $109.44. Also hit were Micron Technologies (MU), down -3.25 to $60.25, Dell Computers (DELL) off -1.19 to $41.56 and Hewlett Packard (HWP), down -1.50 to $109. Most of the sector stocks did close off their lows after the midday sell-off.

Going the opposite direction were retail and airline issues. Retail sales are still strong and Home Depot (HD) gained +1.75 to $89, just off its all time high. ING Barings raised the target price to $99 due to increased earnings visibility and new merchandising initiatives. The Dow Jones Transportation index gained 50.16 points, or 1.78 percent on strength of the oil price decline and selected fare increases by major US carriers. UAL, up +2.25 to $73.63 and AMR, up +1.69 to $61.56 led the way.

The big action of the day, and the week, and the year, continues to be in the Internet Sector. American Online (AOL) bolted +5.25 to close at a record high of $91.50 after touching $93. Rumors of a deal or initiative with Wal-Mart fueled heavy volume in the stock. Yahoo(YHOO) closed at $353.50, up +13.50 to a new all-time high. It's inclusion in the S&P 500 Index triggered a run of over +100 points for the week. Also helping was a positive report issued Friday by Goldman Sachs after meeting with company management recently.

The Goldman Sachs Internet Index, consisting of 17 Internet stocks, added 4 percent on Friday to a record 725.98. For the week, the index was up 16 percent. That index has risen over 100 percent since it's low in August. This week marks the eighth straight week the Internets have ended up. Other big winners in the index for the week include CMGI, VRIO, MSPG and SE, all of which gained over 20 percent for the week.

On the earnings front, Ciena Corp (CIEN) and retailer Gucci Group (GUC) both reported, with CIEN meeting expectations and GUC beating the street by $0.10. Despite beating the expectation, GUC closed -1.50. Next week is busy on the earnings calendar, with the likes of ORCL, MU and CMGI reporting (and probable split announcements from both ORCL, Tuesday after the close, and CMGI, Wednesday after the close).

As for the coming week, the biggest test for the overall market will probably come on Tuesday, with the release before the market of the November CPI numbers. In addition, we will get numbers on retail sales, inventories, new jobless claims and housing starts at the end of the week. At this point, the Nasdaq composite, as well as the Dow look all right. We are sitting above some of the crucial levels we have warned about recently, so the pressure is off somewhat. Guess what? Any of the reports mentioned above could change things drastically, but the likelihood appears somewhat diminished. We may in fact get the Santa rally everyone (including ourselves) talks about, especially if the CPI numbers come in benign. What is important to keep in mind at this point in time is the fact that we are fast approaching the New Year. If the worries and concerns about Y2K come to pass, it will happen soon, and the affect on the market could be sizable. If not, the worries about coming off a record year, renewed inflation fears and a sleigh full of other concerns are issues that the market will have to deal with after the calendar turns. At some point, the overextended situation (we are bullish by nature but admit to a somewhat overextended situation in the market) will have to be addressed. The music is playing folks, as we warned earlier this week. It sounds pretty good to us, as long as it keeps playing.

Louis Horkan
Chief Editor