Mr. Softee Melts the Market

Just when you think it can't get any worse on the earnings front, it gets worse. Late Thursday, the king of all computer tech companies, Microsoft (MSFT), warned for the first time in a decade that revenue and earnings would not meet analysts' expectations.

More specifically, the software giant reported that sales in its second quarter ending December 31 will be nearly $400 million below the $6.8 billion average estimate of analysts surveyed by I/B/E/S International, while earnings are expected to be $0.46 to $0.47 a share, versus an average estimate of $0.49 a share.

Microsoft then went on to cut its 2001 revenue and earnings projections. (If you're going to get undressed, why not get completely naked?) The company now expects to post revenue of between $25.2 billion and $25.4 billion for 2001, a 5 percent reduction from previous estimates. Additionally, earnings per share are now estimated to be between $1.80 and $1.82 a share, versus the consensus estimates of $1.91.

On Friday, Microsoft's stock was torpedoed for $6.31 a share and now changes hands at $49.25, the same price it was changing hands at in October 1998.

Also torpedoed were the Dow Jones Industrial Average (INDU), the Nasdaq Composite Index (COMPX) and the S&P 500 (SPX), which should come as no surprise considering Microsoft is a major component of each index.

The INDU dropped 240.03 points, or 2.25 percent, to close at 10,434.96. The blue-chip average obliterated its 50-dma and 10,500, both of which were purported to be support levels. Next up is 10,325 if the trend isn't reversed.

In addition to Microsoft, the INDU was pressured on Friday by was Hewlett-Packard (HWP), which lost $1.88 to $31.63 thanks to an earnings estimate reduction from Goldman Sachs. Other INDU stocks moving conspicuously lower included IBM (IBM), Intel (INTC), General Motors (GM) and Honeywell (HON). When the session was over only four INDU stocks closed higher: Walt Disney (DIS), 3M (MMM), J.P. Morgan (JPM) and Caterpillar (CAT).

Over in the New Economy exchange, the post-Microsoft blowout was even more severe. The COMPX finished the day down 75.24 points, or 2.76 percent, to 2,653.27, capping off a dreadful week that saw the tech-heavy index lose 9 percent of its value. Technically, the COMPX looks a mess. Since early September, it's been caught in an agonizing downward channel. If the trend isn't reversed soon, we could see 2,250 before the end of the year.

Not coincidently, the demise of the market-cap weighted COMPX coincides with the demise of the Triplets. Since September, Microsoft has dropped 30 percent of its value, Intel has jettisoned 57 percent while Cisco (CSCO) has shed 28 percent.

Speaking of Cisco, don't be surprised if the network routing and switching giant sheds even more value this week. After the market close on Friday, Bloomberg reported that the company had informed the Securities and Exchange Commission that it set aside $275 million in its 2001 first quarter to make up for losses from unpaid customers, which is three times higher than what Cisco reserved for similar expenses a year ago.

The increase in Cisco's loss reserve could be a sign that concerns over a slowdown in networking equipment are legitimate.

Another sign all may not be well in the networking sector has been the recent performance of Sun Microsystems (SUNW). Last week, the networking server giant saw 23 percent lopped off is stock price amid increasing worries that the slowing economy will adversely affect the company's growth outlook. Sun is down a bruising 52 percent from its 52-week high of $64.63.

As for the broader market, the S&P 500 lost 28.78 points, or 2.15 percent, to 1,312.15, which means the broad-based index needs to gain 20 percent in value over the next two weeks to reach Goldman Sachs' strategist Abbey Joseph Cohen's year-end target of 1,575. Don't hold your breath.

Volume in both major exchanges was extremely heavy Friday thanks to triple-witching, which is a quarterly event that sees the simultaneous expiration of futures, options on individual stocks and options on stock indices. Nasdaq volume surged to 2.58 billion shares, which was nearly 50 percent above Thursday's level. Volume on the NYSE spiked 50 percent to 1.55 billion shares, a new record.

In stock news, earnings (or the lack thereof) continue to set the market's mood, which is one reason the mood has been so sour lately. CMGI (CMGI) continues to lose money like a drunken sailor on leave. The Internet incubator fell $0.75 to $8.31 after posting a loss of $638.5 million, or $2.07 per share, which doesn't compare favorably to the $122.3 million loss, or $0.54 per share, for the same year-ago period.

Meanwhile, Artesyn Technology (ATSN) was whacked for $9.19 to $15.45. The company, which makes power conversion equipment for the telecommunications industry, lowered quarterly guidance. It now expects earnings per share between $0.22 and $0.25, well below previous estimates of $0.39 per share.

Another earnings loser was C-Cube Microsystems (CUBE), which fell $5.63 to $11.75. The maker of TV set-top box equipment said it would see lower-than-expected results this quarter, earning $0.07 per share on $61 million in revenue. C-Cube was expected to earn $0.13 per share on $75 million in revenue.

Stinking up the joint in the Old Economy was bleach maker Clorox (CLX), which washed away $3.94 of its value to $30.06, a level not seen in over two years. Clorox warned revenue and earnings for the quarter and fiscal year will miss estimates by about $0.03 a share, or 21 percent less than analyst estimates. This is a head-scratcher to me. During economic slowdowns, do people stop wanting their whites to be as white as they can be?

Fortunately, all the earnings news wasn't negative. Harry Potter's publisher, Scholastic (SCHL) spiked $4.81 to $75.56. The book company earned a $2.95 per share for its latest quarter, 11 percent better than analyst expectations. Driving revenues were the books about the aforementioned Mr. Potter and the just-acquired Grolier encyclopedia unit. The company also announced a 2-for-1 stock split.

In other news, Oracle (ORCL) rose $1.06 to $2.56. The software maker, whose stock had fallen 41 percent since September 1, said sales of its new Internet-based business programs surged during the quarter. Apparently, Internet-based business software is a zero-sum game because Oracle competitors Siebel Systems (SEBL) closed down $2.13 to $77.25 after paring a 12 percent drop, while I2 Technologies (ITWO) lost $0.31 to $50.69 after falling 7.8 percent.

On the economic front, the rate of inflation came in as expected in November, with the Consumer Price Index (CPI) advancing at the consensus 0.2 percent on Friday, though the core CPI (CPI less food and energy) increased by 0.3 percent against expectations of 0.2 percent. For the final three months of the year, the CPI is on pace to rise at a 2.2 percent annual rate, which would be slowest rate of increase since the first quarter of 1999. In other words, the Federal Reserve no longer has an excuse not to cut interest rates.

Speaking of the Fed, the central bank's policy-making arm -- the Federal Open Market Committee (FOMC)-- will announce its decision on interest rates on Tuesday the 19th. The FOMC is expected to leave rates unchanged. However, the Fed is likely to reverse its inflation-controlling bias, which should lead to rate cutes in January. To that end, the February fed funds futures contract has an implied yield of 6.21 percent, more than a quarter percentage point lower than the Fed's current target fed funds rate of 6.5 percent.

Also worth noting this week is Gross Domestic Product (GDP) and the Philadelphia Federal Reserve Branch report on business activity in the region, both of which will be reported on Thursday. GDP is expected to hold steady at 2.4 percent in its final revision of the third quarter, unchanged from its prior posting, while the Philly Fed's index of regional business activity is predicted to fall to 4 percent in December, off from 5.2 percent the prior month.

As for earnings this week, we get a smattering of smaller technology companies and one giant financial concern. Palm (PALM), Liberate (LBRT), 3Com (COMS), TIBCO software (TIBX) and Jabil Circuit (JBL) are expected to report, as is Morgan Stanley Dean Witter (MWD). As always, company guidance will matter more to the market than the actual numbers.

As for trading this week, the key will be the Federal Reserve and the prospect for interest rate cuts. I think the market is expecting the Fed to leave rates unchanged but set the stage for a 25 basis point cut in January, so I wouldn't be surprised if the market sells-off if that's all it gets. After all, last week we saw a classic example of selling the news once the presidential election was finally settled on Wednesday -- the market's sold off Thursday and Friday.

Another factor influencing trader sentiment, as always, will be earnings. The number of companies saying they will not meet fourth-quarter sales or earnings forecasts is up 70 percent from the same time last year, to 362 from 213, according to First Call. Analysts are now forecasting 7.7 percent profit growth for the companies in the S&P 500 this quarter, down from 15.6 percent as of October 1.

With that dreary forecast said, I wouldn't be surprised if the market continues to sell-off this week, particularly in the tech issues. The fact is, there still are plenty of high-tech companies sporting nose-bleed price-to-earnings (P/E) ratios that have a long way to fall before reaching current market multiples.

So, if you're going to trade his week, I would suggest keeping the picks conservative and the trailing stops tight. That's the way we've been playing the market for the past three months and will likely continue to play it for the foreseeable future. The fact is, some of our best performers this month have been stodgy companies with pedestrian businesses like Quest Diagnostics (DGX), Philip Morris (MO) Adolph Coors (RKY) and Danaher (DHR).

Given current market conditions, don't be surprised if more of these types of companies make our current play list this week.

S.P. Brown
Editor