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A better than expected earnings report from chipmaker Micron set the stage for an explosive rally by the markets yesterday morning.  Bullish comments from an Internet stock savant, and better than expected earnings from Morgan Stanley Dean Witter added fuel to the fire.

Internet stocks surged 7.9% yesterday, and helped lead NASDAQ over resistance at 2400 to a close of 2434.43, up 69.15 on the day.  The Dow rose 169.55 and talk of Dow 10,000 again filled the airwaves.  Yesterday's rally was a broad based one, with advancing volume swamping declining volume by a margin of 542 million to 197 million.  For the first time in recent memory, the Russell 2000 joined in the rally and its gains actually outpaced the Dow's on a percentage basis.

We wouldn't get too excited about the possible death of bad breadth just yet, however.  A market needs an inflow of funds to fuel future rallies, and investor dollars have been doing a disappearing act from the coffers of small cap funds during the first 3 months of this year.  The latest data released by AMG Data Services after the close yesterday showed a net outflow of $1.6 billion from small cap and agressive growth funds during the week ended Wednesday.  The exodus from small cap funds is increasing the likelihood that redemption related selling will knock the small caps down further.

We would also take yesterday's better than expected earnings with a grain of salt.  After the bell news from Hutchinson Technology and Inacom painted another grim picture of the personal computer market and could once again set the tech earnings worries train in motion.  The earnings from MWD were great....but, we wouldn't expect anything but stellar earnings from a brokerage stock after a 33%, 5 month rally by the Dow.  If memory serves us correctly, there was nary a record earnings report in sight by the major brokerage stocks last October.   Yesterday's earnings report by Morgan Stanley merely confirms the stock market has rallied, it is not indicative of an earnings turnaround by the entire corporate sector.

The market spent the better part of the day in undecided territory vacillating between fears over corporate profits and "bargain hunting" until a last hour surge in big cap NASDAQ tech stocks helped lift the S&P 500 and NASDAQ to the plus side. The S&P finished the day with a gain of 6.45 and NASDAQ surged 42.41 to 2365.25.

The Dow Jones Industrials lost 4.99 Wednesday, but turned in a positive technical performance on the day with its successful test of support.   We mentioned yesterday that if the Dow closed above the 9647 support level, we would likely see a short term rally.  Indications are that we will get that rally today, with tech stocks leading the way.  Semiconductor issues are up in Europe on the back of a better than expected earnings report from Micron Technology after the bell yesterday.

Overshadowed yesterday by the market's concern over earnings and the bombing of Kosovo was the release of the February Durable Goods report which showed a sharp decline of 5% (1.8% excluding transportation orders which accounted for 2/3 of the decline). Transportation equipment orders and electronics components orders led the decline.  Capital goods orders showed their first decline since last October.   The dismal report only confirmed our view that manufacturing growth is essentially at a standstill, and the U.S. economy must rely on continued strong consumer spending for its growth.

Consumer spending growth in the U.S. at this point is entirely a reaction to "the feel good mood" created by a rising stock market: portfolio values go up, consumers spend more and feed more money into the economy, and the circle repeats.  It is a dangerous cycle that is entirely dependant on rising sentiment.  Add to the mixture a continued decline in the personal savings rate, and you have the recipe for a sharp economic contraction if sentiment turns.

Overseas investor's have also shown concern over the U.S. economy's strong reliance on the consumer wealth effect for its growth.  Japanese exporters (who learned a few lessons from the ending of Japan's consumer led boom in 1989) have seen their stocks experience two selloffs in recent weeks on fears that a drop in the U.S. stock market would put a serious dent in the U.S. consumer's desire to spend.

Yesterday the Averagestock's stopped envying their neighbor when they saw him get beat up by his former friends because he failed to deliver what was expected. 

What Mr. Bigcap failed to deliver was earnings and sales growth that lived up to the lofty expectations of many investors.  What began as a localized pummeling to the shares of PC maker's last month became an all-out assault against stock in all industry's yesterday.  A Merrill Lynch downgrade of Coca Cola yesterday morning, and continued worries about the earnings of Dell Computer, set off a wave of selling in the markets yesterday that cut across all sectors.

The Dow suffered its biggest loss since October and finished the day down 218.68. New lows outnumbered new highs on the big board 330 to 78.   The tech stocks were hit hardest yesterday with NASDAQ falling 73.09.

What has been most striking during the market's decline this week is the deterioration shown by the groups which have led the market during its post October rally.  The markets are now left with no leadership to carry them higher.  The old leaders have seen their better days: the techs started to crack last month, and the rally in financial stocks has been stopped dead in its tracks by interest rate fears.  Last week's anointing of the new leadership, the airlines and the oils, was doomed from the start. It took a week, but traders have now realized that the two groups can not simultaneously rise.  The airline stocks have already turned south, and the oil sector is looking overextended and was never an option to begin with (a little thing called "inflationary" automatically ruled it out as a possible group to lead a market rally).

With a complete lack of leadership (and no possible successors to the leadership throne) added to the market's list of technical woes, we expect to see the Dow lower in the months ahead.  However, we would not recommend going heavily short the market just yet.  The "unexpected" of which we have spoken ad nauseam during the past few weeks can work on the upside as well as the downside.  The potential exists for a sharp relief rally if (or when) the situation in Kosovo is resolved.

The major story in yesterday's decline wasn't the Dow's inability to satisfy the media's thirst for a close above 10,000, but rather it  was the Transport's continuing retreat after failing to break above the 3461 resistance level last week. The Dow Transports closed the day below the 3282 support level at 3275.68.  The next downside support for the average is at 3150.

The technical deterioration of the market continues to gather pace with the transport's take off attempt aborted by a realization by many traders that "yes, Virginia, rising oil prices are bad news for the airlines", the Russell 2000 in a year long bear market, and the advance/decline line's level at Dow 9900 bearing an eerie resemblance to the advance/decline line's level at Dow 7400.  Even in a new paradigm economy, divergences still matter to us and they are still warnings that a trend is near a turning point.

Divergences are also becoming apparent in global sentiment. While sentiment in the U.S. remains bullish as Americans continue to decrease their rate of savings and increase their appetite for equities, investors in Europe have begun the journey down the slippery slope of sentiment from euphoria (euro) to fear (economic). Stock markets and economies in Germany and the U.K. have likely seen their highs.

European markets are down across the board this morning on worries that slowing economic growth will translate into lower corporate profits.   While many investors have forgotten that the U.S. is part of the global economy, we suspect that will change in the year's second half.  The slowdown in Europe will likely make its effect felt in the year's second half on the profits of the large cap stocks that have led this rally.

A slowing Europe is a worry for the future, but not for this morning.  Today U.S. investors will have to contend with domestic earnings concerns.  The box makers will come under renewed pressure after a report by PC Data showed that PC sales growth slowed to just 0.8% in February.  Early March PC sales show no signs of recovery.  The financial sector will be weak today on the backs of an earnings warning from First American and rising interest rates/inflation fears.

An afternoon downgrade of IBM, and the ensuing obligatory market retreat, temporarily dampened the spirits of market participants, but only for a day.   The new era that we have entered will continue this week, with little in the way of economic reports to hinder its advance.

The new era of which we speak is the era of   complacency, the era of capitulation to the prevailing dominant trend.  True, it has been seen many times before, but not by the majority of the present generation of market followers.

As the Dow set new records last week and played a game of tag with overhead resistance, the new era continued to gain adherents.  From the former Fed Governor who capitulated to the belief in a new economic order, to the technician turned cheerleader of the new paradigm, the new era of complacency continued to grow. 

Perhaps nowhere was this capitulation to the prevailing sentiment more apparent (and its ramifications more dangerous) than in the very man who once set off a market storm with the words "Irrational Exuberance", Fed Chairman Alan Greenspan. With one of its early antagonists now converted, the new era is fast running out of potential new members, and therein lies the danger.

When the ranks of non-believers have thinned to a handful, and there is no one left to enlist if new recruits are needed to stave off a threat to the trend, the prevailing trend is defenseless against the unexpected.

The market's current reliance on the previously unreliable (OPEC production cuts and economic recovery in Japan) to sustain its upward motion increases the chances that the trend is nearing its final terminus.