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The good news on Friday was that the big sell-off was a one-day thing. My strong suspicion is that the long-awaited correction is done and that the market held up strongly enough on Friday to convince the cynics that they shouldn't push their luck any further at this point.
The Consumer Price Index for November was okay, but core inflation (taking out food and energy) was higher than expected. This was a positive report. Components that contributed to higher core inflation included medical care, housing, recreation, tobacco, and other goods and services. Other than food and energy, clothing was the only component to show a significant decline. A little inflation is actually good and a sign of a healthy economy. It would have been bad if the report had showed deflation.
The Business Inventories report for October showed a nice decline in inventories coupled with a nice rise in sales. This was a positive report. The inventory to sales ratio continues to fall. That's a good sign that inventories are in reasonably good shape. These results "hint" that the manufacturing sector may be very close to finally bottoming out. Note that this report is describing an economy six weeks after the fact. The November report should be even better.
The Industrial Production report for November was a mixed bag, with the decline being smaller than expected, but primarily due to increased motor vehicle production. Also, capacity utilization fell by less than expected. This was a positive report. But people are still anxious about when all this bottoming will finally hit bottom. I still expect that sometime in Q1 we will finally see an uptick in the manufacturing sector.
The Economic Cycle Research Institute (ECRI) Weekly Leading Index (WLI) moved up nicely again and has now fully recovered to where it was in late August. The six-month smoothed growth rate is still negative, but also recovered to the levels in August. This was a very positive report. It suggests that we could very soon see evidence that the recovery really is taking root.
Nasdaq has now closed above its 100-day moving average for 23 days straight and above both its 150-day and 200-day moving averages for 9 days. But we are below the magic 2000 level. The 50-day moving average continues to turn up. The 100-day moving average is flat and the 50-day moving average has just crossed above it; this sometimes suggests that a rally could be imminent.
The CBOE Market Volatility Index (VIX), which measures the level of anxiety in the market, FELL by 2.73% on Friday to 26.97, which is still in the lower end of the moderately high anxiety zone (25 to 30). VIX actually leaped up on the open to a day-high of 27.88 and spent much of the day in a range from 27 to 27.5. Only when the market began to recover sharply around 2:30 p.m. did VIX fall sharply, hitting a day-low of 25.40, before rising just a little into the close. VIX suggests that the correction really is over and that people are not too worried about a deeper correction.
The Nasdaq-100 After Hours Indicator had a positive but erratic tone for the entire Friday evening session, closing up 1.57 points. Maybe a little optimism is creeping back, but mostly people are just anxious whether they should wait for more of the dust to settle before wading deeper into the market.
Fed Funds Futures suggest a 16% (down from 24%) chance of a quarter-point cut in interest rates at the January 30 FOMC meeting. In other words, another rate cut is VERY UNLIKELY unless the economy does worse than looks likely. The bond market is virtually convinced that the recovery is a done deal. I expect the stock market will realize the same, real soon.
The negotiations over the fiscal stimulus package are still grinding along, despite the occasional impasse. Something will happen. It's in everybody's interest for it to happen so that nobody gets blamed for preventing it. Afterwards, they can all crow that they are responsible for it coming together and they can all grumble that the other guys prevented them from making it a better package.
The "war" is making real progress, but still has a very long way to go. Don't get too excited or depressed by the incremental reports. UBL may still be on the loose, but he's far less likely to have spare time to reflect on planning of additional terrorist attacks. And any attempts by him to communicate with his cells will be very difficult. We monitor all the signals, we are more carefully monitoring movement of suspicious characters, and just the sheer number of security forces with their eyes open dramatically reduce the chance of success of additional terrorist acts. That's not to say they're impossible, just far less likely.
The mess in Palestine is at least not deteriorating more rapidly. In truth, Arafat should send a thank you note to Sharon for doing a lot of the dirty work that Arafat himself was committed to carrying out, but that was so politically difficult for him. The situation will undoubtedly have further flare-ups, but strong, decisive action backed by support from the U.S. could well finally get the ball rolling again towards some kind of peaceful resolution. Despite all the public gnashing of teeth and showdown at the U.N., I'm sure that few Arab leaders would privately blame Israel for taking military action in response to the dramatic suicide attacks. If Israel had not responded, that would have been taken as a sign of weakness and earned even less respect.
Keep an eye on advertising. Media companies are still struggling, but companies will start ramping up their advertising spending again as soon as they have the money. Once they do, that will be a good sign the companies also will be starting to loosen up the purse strings for capital investment as well. It's simply about corporate turf: it's very difficult to let one department spend and keep another on a tight leash. Advertising is a very easy thing to turn on and off compared to acquisition of technology products and services, so it will be a leading indicator. AOL (AOL), Yahoo (YHOO), and DoubleClick (DCLK) are very sensitive to advertising demand. Leading-edge investors will start buying into such companies well in advance of improvements showing up in official quarterly reports.
Q1 is traditionally slower than Q4 for tech businesses as well as anybody that benefits from holiday seasonal spending. So don't be disturbed when companies "warn" that they will see sequential declines in revenues and earnings from Q4 to Q1. Somehow, the numbers need to be seasonally adjusted to compare them relative to past years. The problem is that Q4 and the past two years were so out of the ordinary (e.g. Q4 of 1999 in preparation for Y2K) that it's very difficult to come up with a model that works. The best we can do is focus on management's subjective judgment as to whether they feel confident that orders and customer interest feel like they're picking up relative to what management's expectations would have been for a "normal" seasonal pattern.
As we get deeper into the quarterly "confession season" we will certainly see a number of tech companies give warnings, some very dramatic. But I think the market just finished preparing itself for all that. Actually, the dip last week may have been more a matter of preparing for the weakness in Q1 that recent confessions warned about. We could well get back into the mode where the market can rally even in the face of negative news. Personally, I suspect that Q1 will end up being significantly better than many people expect. Also, I strongly suspect that companies are now being ultra-conservative so that all the bad news will be behind them so they can start the new year with a better than average chance at beating Q1 estimates.
Don't fret too much about additional layoff announcements here and there. The bulk of the layoffs are done and it's just a small minority "mopping up". That's just the way it is at a turning point. Companies want to be in as strong a position as possible going into the recovery. They want absolutely zero dead wood holding them back. And they do not want to be putting out negative news as the recovery progresses. There's a favorite sales tactic: salesmen will ask their prospects if they really want to even consider the competition when they're so shaky that they just announced more layoffs. Best to get all that bad stuff behind you ASAP.
It's Monday, so it's time for me to do my weekly dollar-cost averaging (DCA) purchase of S&P 500 Tech Sector "Spider" (XLK) LEAP call options.
Stock market activity could slow dramatically as we approach the holidays. Even Friday could be rather slow. Less activity means more volatility or sharper swings in prices. This makes it virtually impossible for anybody to safely predict whether the market will stay in a trading range, plunge further, or recover sharply over the next two weeks. Some would argue for a Santa Claus rally. Others will stick to the too-far-too-fast mantra. But true investors can just either ignore the ups and downs or buy the dips.
We could see some tax-loss selling, but it's so unpredictable. We could also see more selling by investors who got into the Fall rally early and are now worried whether a continuation of last week's correction might continue to wipe out more of their profits. The hope is that both will be balanced by investors who want to get into the market before any possible year-end or January rallies.
The bottom line: The Fall rally (58 days old) is still intact. 2 more days of Nasdaq above its 50-day moving average and I'll "officially" label it a genuine bull market. I don't expect much more of a dip (3%, if at all) until after we've rallied well above 2100.
Short-term economic outlook: The trough for the recession was probably the second half of October and the economy has slightly improved since, even if not yet noticeable by economists (they won't have a handle on November until January). As December and January progress we will gradually start to see more incremental signs that the economy is beginning to recover. Not a large improvement, but at least the trend will not be downward. Some indicators will continue to decline, even as others begin to stabilize and some even begin rising. But, October and the first half of November were probably bad enough that Q4 will "print" as a decline in GDP. Employment will continue to fall until GDP finally breaks above the rate of productivity growth, probably late in Q1 of 2002. The manufacturing sector won't trend up from a trough until sometime in Q1.
My tech stock "safe" signal is still stuck at 0.0 since none of the major tech companies is yet publicly claiming that they have evidence (other than "hope" or "hints") that their business has started to accelerate out of the tech downturn. My "safe" signal requires at least 20% or 1 out of 5 of the top 25 tech companies to signal acceleration. Expect at least two quarters to elapse from the time of the first indications of an upturn and the return of solid growth. The theory is that the stock market should begin a sustainable rally six months in advance of the return of strong growth. Despite recent events, I continue to peg Q2 (May or June) of 2002 as the timeframe for the return of relatively strong growth for the bulk of the tech sector.
Jack Krupansky
Updated: December 16, 2001 11:23:58 PM -0500
Copyright © 2001 John W. Krupansky d/b/a Base Technology