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Navigating A Sea of Chaos

December 8, 2000

Elements of a bottom gelled . . . over the previous week, commencing with last Thursday's turn to the upside, struggling and meandering, but nevertheless moving forward as anticipated from a very rocky start; well before the Fed Chairman's resolutely aware statement about U.S. slowing. The sequel to Tuesday's projected 'melt-up' behavior was an equity version of 'Pearl Harbor' on Wednesday; though the attack was not the kind of 'carpet bombing' the market had become so accustomed to in recent weeks. And while the news backdrop had more specifics today than the upside explosion, which was based on an anticipated change in monetary tone (combined with a dose of short-covering), the fundamental backdrop is generally rearview mirror worries about the already-known-to-be troubled Q4/Q1, than a report card on the health of the markets next year.

Or is it? It's very tempting to label Tuesday a one-day-wonder or false 'sucker rally' though that is oversimplification to the extreme in our view. The bear market is old, not new; the decline in tech is ongoing, not initiating (and working towards completion), while the financials have been dealt a face-the-music sobering review of their loan portfolios that has not only been discussed here this past couple months; but has something likely directly to do with the Fed Chairman's remarks on this subject (where he talked about lending standards contributing to economic slowing risks). Of course he knows better; having commenced taking the punchbowl away over a year ago, while at the same time expanding the monetary aggregates in the face of a tightened policy guidance.

Now the Fed has to unwind that policy, and as we've argued for several weeks, the nuance of so doing is reflected in the behavior of not just T-Bonds (that we've been bullish on for a year as we reversed bearish-to-bullish at the 89 level then), but in Fed Funds futures and 10 year Notes, as noted here just last week likely signaling a coming policy directive shift. We also pointed out (it bears noting here) that the initial reaction to policy shifts (in this case his speech was sufficient as it was incredibly clear) sparks a celebratory rally, a sharp profit-taking wave; then often a period of ebb-and-flow while the market absorbs the implications of forward policy changes, and a still-burdened domestic earnings picture, on the near-term. That's why we pointed out history in such matters doesn't always have the market higher three months later; but almost always (this is reserved forward thinking; but the general idea is provided).

Navigating a 'Sea of Chaos'

Things are 'up in the air' in some aspects; which today's particulars made abundantly clear. Sure, we suspect this ultimately gets resolved (reserved). However, there are concerns (as we hinted at last night) about why the Fed Chairman was uncharacteristically precise in his remarks; such as realizing that the Fed is already way behind the curve on this (as we've argued since the last FOMC meeting), and must do everything they're able to speed things along towards ease, and towards stoking the aggregates so the banks will be inclined to open-up a bit (later next year).

If that implies we suspect the economy is bordering on (or in some cases already has) 'fallen off a cliff'; or the Chairman fears such a falling, then so be it. Many anecdotal reports (and they're so mixed, but we denote a pattern) support a very sluggish economy at best; collapsing at worst. Of course the toughest part is knowing when the market starts discounting the recovery; and trying (it is not always easy) to estimate how hard the landing will be. Given the reticence of a Fed late in a year to change rate structures, the chances of the economic landing being harder than just a soft ideal one are increased. However, the extent of subsequent egress from the hole will be too.

Our own input has for months supported the economic slowing ideas; though some areas remain mixed (such as housing, which is stronger in some regions than others), while others are still in a formative state (such as wireless, which we've only recently taken an interest in because of price levels of shares, and the shortened distance-to-market for some products and services after the many years of premature hype in the sector that we generally avoided, or played conservatively by virtue of infrastructure -comment balance reserved-). Dozens of earnings warnings basically are running into a clearly-stated monetary policy reversal coming up, which we believed for some time was inevitable, so actually is a bit tardy being proclaimed. (There are late year impediments.)

Comments about the timing of the resolution of this conundrum are reserved for subscribers. We also reserve a majority of remarks Daily Action; Technicals Bits & Bytes & Economic News. In any event, if we were Captaining a ship on this ongoing and challenging 'Sea of Chaos', we'd seriously consider extending the stabilizers about now too.. so that's what the Fed Chair started.

The finessing of this mostly includes the idea of a primary low (especially in value or deeply hard hit techs, that are destined most likely to survive and even prosper) this year, with some testing a bit after the first run-up (apparently immediate) and then more upside, before more testing likely in next year's action. Intraday (Wednesday) we (900.933.GENE hotline) took our 2000 point gain on a 1345 December S&P long; stepped aside, did another long for a 400 gain; a theoretical short for a 600 gain, a few small efforts; for a net of something like between 2800-3200 ahead for the very irregular and heavy session following our tremendous gains with Tuesday's entire rally.

So for now, the SPZ resistance and support are none other than today's highs and just under the lows (not often that way, but is nearly coincident this time), with key support around Tuesday's or so low point (a little above that actually), as that area (around 1340-45) represented the breakout of the prior accelerated downtrend; so might be important as regards the battle surrounding that. In any event, it's all happening fairly rapidly, with a penetration of that area bringing-out veritable squalls of selling, but unlikely sustainable on the downside either, which makes it increasingly a kind of market we should enjoy for S&P trading guidelines, but tough on longer-term investors.

As for the NASDAQ and Nasdaq 100 (NDX), we have key daily levels (reserved). For the Dow Industrials, 10,500 or so is titular support, though it is not something we'd want to get too doctrinaire about. By that I mean that this market is so fast and emotional, that even penetrating that wouldn't be any assurance it didn't turn back upward in an hour or day or two; given the sensitivity for news, and the seasonality. That includes what we suspect are final throes of pre-ex-dividend fund sales, going on right about now for that matter. (Then the balance of this call.)

It's prevailing 'conventional' wisdom that tech funds will be the most heavily sold; if so wouldn't it follow they'd be the most likely to snap-back in the weeks thereafter, with at least that pressure on their jugular behind? Normally yes, but they also have to address very varied earnings results of course, and in many cases warnings about a soft Q1 of '01, which also is generally no surprise here. To us the key is their view of the 2nd half of next year, which probably comes down to what kind of landing the U.S. economy has; if soft (or not too hard) they'll do surprisingly well, if harder than that; then they will do better down the road too, but curves enroute will be more frequent.

The nuances crisscrossing this market have told us for days now that the next meaningful move was to be to the upside, not the downside. And much of this may surround expected post-policy-shift celebration and profit-taking; though it's clearly deeper than that. Many pundits are debating 'compression', talking about a need for sustainability, or even worried about new overall declines (something that would definitely be stimulated by today's sloppy action). That's good in a sense, (unfortunately, reasons why that's good down the road are reserved). Let's not worry about that yet; for now we see downside action working, then resuming the upside, although absolutely by now conditioned to expect the unexpected from political news; along with earnings warnings that were expected, and can briefly become efforts to 'bear' intervening action at particular moments.

We described Tuesday's forecast rally as a 'Big Party for a Small Punchbowl', as no doubt we did get a policy inclination stance; though it's too bad the Fed is less likely to immediately move (though they can if things get dicey enough on the banking or derivatives front) to cut just as yet. As we remarked last night; always worry when the Fed is easy to understand; that likely means the economy is really awful. Slow holiday sales following autos and modestly slow housing data, means the Fed surely did its job, and now risks going overboard if they don't change their mode into a stimulative one. I believe the Fed Chairman said as much, regarding credit concerns and lending practices. Some analysts (especially those who just recently downgraded computer and semiconductor or related areas) are debating whether glasses are half full or empty now; which is desirable in terms of fostering uncertainty; hopefully exhausting last remaining weak holders.

Hence, it remains our view that the handwriting is on the wall for the lowering of rates and policy, that it precedes pullbacks (usually works that way) as subsequent spates of hard earnings hits; but that long-term investors will continuously (continued reserved ongoing strategies). We were delighted to see the skepticism at Tuesday's end, and again on Wednesday (as it is reflected by a fairly deep discount in the December S&P), as we suspected it should not deter an institutional understanding of what these shifts likely mean for the future; as most professionals are aware of the history denying the immediately successful staying-power of the first hint of shift on the part of the Fed; though are aware how that impacts the market some months forward, nearly always.

In summary . . our view a week ago was that it was time to increase, not reduce, commitment to the markets, and where possible even to nibble into a variety of diversified stocks, during periods of residual weakness, not sell them, before we moved into not only the Fedspeak day, which got our short-term targets achieved; set up more than desired profit-taking, but isn't a reversal . . yet.

The initiation of one of the remaining restraints on price movement; the ex-dividend capital gains distributions of funds (some down for the year) at this particular time of the year remains a factor. The ramifications should be favorable thereafter, thus much of the buying seen before Tuesday was as noted, likely preliminary positioning, with the bulk of the to come after profit-taking waves. As for the 'cues' of this; the market's inability to decline measurably beyond the recent downtrend breakout points (much less former low points penetrated last week), would be the desired action.

The McClellan Oscillator on the NYSE is around +60 on the NYSE now, with the NASDAQ dip to around +1 (a minor negative 5 change). Admonitions that any futures shorting be kept on a short-leash, as rebound considerations remain at the forefront of our thinking on this intervening downside squalls of selling remain. So, it's not out of the question that a 'bull trap' (we'll use the most common definition; not as we've known it for years) can be constructed by the bulls with the decline underway now; but with a resolution not necessarily taking place until next week, and so very dependent upon political resolution, and maybe tying-into Expiration. As of around 7:30 p.m. Wednesday evening, the S&P futures sport a -246 discount to cash around 1349 about now. The regular Chicago close was 1354. The (900.933.GENE) hotline is currently flat futures overnight.

It is our plan to shift guidelines to the March S&P (SPH) shortly after it becomes the front-month contract; but typically when the majority of vendor quote services shift to that premium quote. We of course have both all the time; but many don't; so that's why we tend to cover it thusly. Today it is notable that the March S&P finished at 1374, with an approximate 2250 premium over cash.

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