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Market's Moment of Truth

July 6, 2000

A combination of ingredients left investors bereft . . . of optimism Wednesday, despite what in several ways is data that supports a longer-term optimism towards the market. Parts of this in fact contributed to the day's rout, such as the expected decline in Crude Oil, which impacted the large-cap Senior Averages negatively from the get-go; though the implications are favorable, not negative, for the Energy-intensive stocks that (where culled-out) mostly firmed in this heavy day. In other words, what's bearish for Oil stocks, if sustained, can be bullish for many other sectors.

Absolutely amazing . . . are the coterie of money managers (and momentum players; often one and the same) evacuating the mainframe and related software stocks, as if the soft order-flow in the 2nd Quarter meant something horrendous about the future. It does not, and relates around the heart of why we thought this year's 1st half would be softer than did the broader consensus.

Our view held that few industries or companies would be purchasing mainframes, or anything for that matter, until they digested the costs involved in transitioning to the year 2000, and that such IT "expense lockdowns" would even await the bridging of a business-slowdown gap. That has in fact (mostly) occurred, thus should be surprising "knockout news" only to those who stayed too optimistic as relates to such stocks coming into and through the 1st half (though we thought for a great many players who evacuated on the year's first tick or into parabolic subsequent thrusts of a failing nature, that April / May would provide lows for a number of stocks and areas, which to date, has been the case). We addressed this just the other day, with respect to IBM (IBM), and though we don't own it or the myriad of stocks cremated today (though some of ours were down too, viewed as extended and in corrections for weeks, however none had the percentage drops of the headline-grabbing nature of others), and while we're not (at least yet) interested in buying IBM or a Computer Associates (CA), that incidentally we were once short (too bad not today), we do not except the logic of those who only now sense something becoming wrong with such stocks, or additionally Semiconductors (SOX), which came under pressure, although nothing like the mainframe and software areas.

In our view, it's probable that some otherwise-normal money managers were shaken by today's warnings, especially if they accepted the overblown earnings estimates at face value for the year from some of the "estimators". We didn't, and thus actually think these rearview mirror remarks in either analysts or corporate statements about contracts deferred, and money not "booked", very much fits the expectations of customers deferring to the second half, and recovering from costs associated with Y2k adjustments, before they make new commitments. On a smaller scale, we'd even expected sloppier results from the PC sector for the first half (some reports are surprisingly robust for the recovery from Y2k and traditionally soft 2nd Quarter), and then better later this year as the first bug-fix (service release) comes for Window's 2000, and the next-gen Pentium 4 rolls out, with its very significant 400 MHz front-end bus, which basically triples throughput from older offerings, and makes good use (first time really) of high-speed memory, such as RDRAM and of course is expected to bring-in the orders for such gear from IT managers not only awaiting all of it for technical reasons, but constrained by managements since '99, from buying sooner anyway.

Around the Quads

Nevertheless, we know how poorly modern portfolio theorists grasp the idea of handling any sort of business slowdown. And it's no longer something not taught at the Harvard Business School. Since the huge Energy-induced inflation of the '70's, and the plunges of 1987 and later 1990 (it had a recession component, while the 1987 crash actually was a humongous forecast hiccup, while the 1970's was the worst modern stagflation), cyclicality has been studiously watched for signs of turns. Well, today one analyst says he sees early signs of the cycle turning down in the chips, coming at the same time as Oil was hit (a plus, but impacted several large Oil stocks, that a few analysts have been buying of late, though we've been expecting to become toppy as noted occasionally), and the new Quarter got going. Combine that with CA's story, and buyers avoided the market like they were groping for leadership during the "death fogs" in London's days of old. First of all, semiconductors (commentary and analysis reserved for subscribers).

Simply put: we agree price got ahead of itself in many stocks, just as it was overdone the other way, in what to many seems like an eternity, but was only a couple months ago. What we totally do not agree with is the idea that "demand" is contracting for the next couple years there, or in a slew of other areas (such as the mainframes, where new buying and product cycles weren't even anticipated until the latter portion of this year, continuing into next year; especially after costs are absorbed of the Y2k transition, long forcast to suppress 2000 sales, and IBM's November rollout of their "refreshed" models, which may be ordered by key customers sooner, but not booked).

Where impacted by the long-forecast pounding (a year old actually) in e-tailing; of course results would be mediocre (just one reason we tended not to embrace storage or software firms whose primary clientele tended to be in the older e-commerce stocks). How anyone could acknowledge the consolidation in that sector, and not expect the software and storage outsourcing companies they use to be effected, we don't know. As for e-tailing itself, this year and next should see a big bottoming of the first-generation's collapse, evolving into increasing consolidation, many of which are either occurring or in the works; while second-generation e-commerce (comments on rollouts are reserved).

As for ideas of the "chip cycle" (fundamental demand) peaking, we just do not agree, especially with those who think the technology cycle pauses six months from now. Again; we're now going through a rotating correction (and nearly-typically softer summer), in a group that had a superior performance during the Y2k transition, and hence is closer to seeing normal price performance patterns than the stocks that were decimated earlier in the year, or victims of Y2k-related delays.

Nevertheless . . . we do respect the activity that's going on here, and definitely didn't get the firm post-holiday market we desired; recognizing that Wednesday's action structurally gave back a bit more than was gained Monday, though again the worst-hit sectors were other than favored here.

There was pressure in the big optic stocks, an absence of buyers in tech in general, and a hard hit to the Nasdaq 100 (NDX) of about 155 points, in particular. However, just as in the S&P case, we have not had any key numbers taken-out above the market, nor supports broken (at least as of yet). And therein lies part of the conundrum of this market. Certainly, you cannot replace the contribution technology plays in the current environment with "value plays" in "old economy" type stocks, even though some strategists think that's where the better values are now. As noted here before, we don't disagree with the value aspect, but do not expect this stock market capable of being sustained without technology being a player (what's needed now is a reserved comment).

Technicals; Daily Action; Economic News; and Bits & Bytes: (all reserved subscriber areas).

In the interim, we're being as flexible as possible on the hotline (900.933.GENE), as guidelines anticipated being long more, but outside of a couple small scalping losses, did mange to capture a solid short-side theoretical gain, looking forward to a rebound coming off Thursday's a.m. low.

For investors in general, the (technical) backdrop becomes crucial if tech stocks can't stabilize or if a few more sectors succumb. At the same time, many group patterns remain independent of a broader perspective of the market, which makes it tough to paint equities with a common theme. If there is one, it's (discussion of certain individual stocks is reserved for readers). They are not all the same type of companies, and shouldn't be lumped together by financial media as a mass.

As for cyclical stocks of the traditional nature, they are the ones most commonly impacted by the higher interest rate environment, and which actually should tend to lag presumed peaking of Fed monetary policies the most. We've said that before, and there's no change in that argument. We would note that if traditional cyclicals combine with computers and chips to break, then the stock market goes down, which is why despite a fundamental optimism about the computer business, we remain absolutely aware of the posture and technical position the stock market finds itself in.

It's in trouble, but not down for the count; remaining in "mortal kombat" between "old economy" stocks and the "good" stocks of the "new economy" which are being lumped with those laggards impacted by the preceding expected crash of the craze, and which are now seeing that reflected in earnings, which would seem to have been logical for everyone to expect for Q2. As for the market "climbing a worry wall"; well, it did that coming out of the Spring hole (reserved).

As a result, while very open-minded to the market gradually discounting the future, not the past as some of the momentum-types insist on doing, we're going to remain flexible for a Summer hit only if the market requires that. At the moment, we have a sloppy market in the wake of forecast comebacks out of the April / May hole, and we do not have either a breakdown below support or a clearing of the technical resistance. We did not expect much of a chance of resolution in June; see little surprising in the computer sector (having forecast the first half results essentially before the entire year started), and do not throw all techs into the same basket as some commentators.

At the same time, there's only so much pressure before any dam can breaks, and this borders on a leaking one. Also noteworthy; nervousness we hear from strategists & fund managers reflects (we think anyway) as much frustration about the year's first half mutual fund performance, as it does future expectations; maybe more. Again; the stock market's a discounting mechanism, thus results for the 2nd Quarter should have been anticipated by realistic purges long ago. Some did; others clearly didn't or you wouldn't have the CA's of this day. And that gets our attention, though so long as we don't get a support (defined) breakdown, we'll give the market benefit of the doubt.

In summary . . . the LEI (Leading Economic Indicators) were slightly softer, but incapable of a market-moving impact, in a climate like this one, which was overwhelmed by selling in software stocks, with concurrent (disconnected) selling waves in a number of other sectors. We're aptly concerned, but not yet convinced the market's going to go off a cliff. TheMcClellan Oscillator reading of +48 was down, by around 9 from Monday's posting, holding well above the zero-line.

For now, while we do hold a guideline long from 1462 in the September S&P (exited early Thurs. with a reenter of the guideline at 1459) and interested as to whether there will be a reticence to take positions in-front of Friday's Employment Report. Then we likely get a clear and meaningful move, as this narrowing "battle" can't continue without a resolution much longer. Near 8 p.m. ET, on Globex, S&P premium is 1847, with futures around 1464.70, which is up 140 from the regular Chicago close.

Gold is still being mined and refined at the rate of almost 2,600 tonnes per year.
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