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The liquidity driven search for the out of favor laggards of the new era rediscovered the gold stocks yesterday, with the .XAU inching above resistance at the close.

What liquidity giveth in one sector it taketh from another, and the S&P 500 and NASDAQ continued to bear the brunt of that taking.   The drug stocks continued to adjust to their new home: the outhouse, while the other deposed leaders: the retailers, biotechs, and airlines floundered about in search of a new home.  A sudden realization that expectations are nice, but some hope of turning a profit is better helped sink Amazon.com and dragged the tech sector along for the ride.

The fast moving tide of sector rotation (or should we say the fear of being less than 100% invested in a "sure thing" money maker) is likely to continue today, with traders once again falling in love with the Internet sector in the wake of Infospace's better than expected loss and 18 point runup in after hours trading, and heading for the border at the sight of a Case (CSE) of Deere (DE) in New Holland (NH).

It is the Deere part of the equation that gives pause and makes us say: too much, too soon.  If you suffer through our morning rants each day, you know by now that we view the recent indiscriminate herd stampede into anything cyclical as a case of the blind leading the blind into a river of trouble without a paddle.

Not all cyclicals are created equal, let alone in the same stage of recovery, and to blindly plunge into them is a sure fire ticket to trouble.   Deere's after the bell revenue warning, and Umberto Quadrino's (CEO of New Holland) statement that "the conditions that depressed sales of agricultural equipment last year have not eased in the new year" should ring a warning bell to investors who are thinking of blindly jumping into the cyclicals without first considering which part of the economic cycle a  specific stock will prosper in.  Lesson 1: the machinery makers like Case, Caterpillar, and Deere are not the companies to buy during the beginning stage of a global economic recovery cycle.

The world wide mass move into the cyclicals following the ECB's rate cut has lifted many stocks in the group to valuation levels that discount a full global recovery, which is anything but a given at this point.  Yesterday the Morgan Stanley Cyclical Index hit an all time high.  Maybe it's just because we're out of step with the newly created valuation methods of the new paradigm, but we would like to see a corresponding rise in earnings when an index hits an all time high.

While the new found rage for the basic industries continues unabated on these shores, the allure of the cyclicals is already starting to lose its luster to many global investors.  Lower than expected earnings from the German chemical trio of BASF, Bayer, and Hoechst have German investors doing a rethink on the cyclicals.

A recovery in global economic trouble spots is still questionable at best.  The sharp run up in the price of oil this year has likely tied the hands of the ECB's rate cutters for the time being.  Figures released in Germany yesterday showed a sharp 0.8% oil related jump in the price of imported goods in March.   If the rise in import prices continues, the ECB could be forced to raise rates, a move which would postpone a European recovery.

Japanese investors are also rethinking their recent cyclical buying binge as economic releases continue to point to an economy that continues to struggle.  Today's release of Japanese Jobless rate figures showed an increase to a record 4.8% Unemployment rate.  Household Spending figures also failed to show that a recovery is at hand.  The Japanese government will likely be forced into another round of public works spending to prevent the economy from sinking further.

While the Dow Industrials staged a midday rally through 10,900 and financial commentators eagerly twiddled their thumbs in anticipation of Dow 11,000, NASDAQ and the S&P 500 were headed in the opposite direction, weighed down by their former leaders: the brokerages, techs, drug stocks, and the Internet sector.

Bullish comments from Abby Joseph Cohen of (IPO bound) Goldman Sachs aside, we saw little to like in yesterday's action. The continued retreat of the former leaders remains worrisome.  The market needs positive leadership from the drugs and tech stocks if it is to move higher. At this point neither group is capable of providing the needed leadership.  The drug stocks have turned the sentiment corner and entered a downtrend, while the tech stocks are still severely overextended and in need of a further correction.  The tech stocks could come under further pressure today as they are dragged down in the wake of a falling Amazon.com led Internet sector. 

The performance of the Internet stocks yesterday following better than expected results from AOL and DoubleClick is another potential thorn in the ability of the market to move higher.  As we have said (perhaps one too many time) before, during bull market's investors tend to see the glass as half full, and they disregard the bad aspects while focusing only on the positive.  A bull market will stay in place as long as investors continue to discard the negative, but when the full story begins to be contemplated once again the upward movement is in trouble and a change of trend is at hand.

That moment of trouble may have arrived for the Internet stocks.  Last Thursday we said, "How long the smoke screen of the beating of diminished expectations will be able to both drive stock prices higher while covering the declining quality of corporate earnings is a question that will likely determine how long the current run endures".  The smoke screen appears to have lifted from the Internet sector.  Amazon.com released better than expected numbers after the close yesterday, beatings revenue estimates by $33 million and earnings expectations by 6 cents a share.  In a sign that sentiment may have shifted towards the sector, investors chose to focus on the negative aspects of the company's release (the glass half empty) and sold the stock off in after hours trading last night.

With sentiment towards the drugs and Internet stocks shifting, the techs overextended, and perhaps more importantly, the brokerage stocks failing to confirm the last leg of the market's advance, the burden of leadership falls to the cyclicals and oils.

The other explanation for yesterday's market action is simply more of what we have witnessed over the past few months: the law of diminishing returns at work in a sea of liquidity. The rapid runup in equity prices since last October's lows, and the accompanying manic rise in Internet stocks, brought to market an abundant new crop: the novice investor/trader with a compelling need to take part in what was perceived to be a can't miss ticket to the good life.

Yesterday's rise in cyclical shares was primarily due to a fear that is endemic among the newly arrived market participants: a fear of missing out on   a sure thing, a fear that being less than 100% invested in the stock market will prevent the attaining of the pot of gold at the end of the rainbow.  The sector rotation that has periodically swept through the markets in recent weeks has been caused by this fear of separation (from a perceived sure fire winning strategy which can only be achieved by remaining 100% invested in the market). Rather than a sign of market strength, the recent periodic shifting of funds into the cyclicals is a sign of market weakness and vulnerability in a mature trend because it is based on fear and the accompanying greed which a strongly rising trend ultimately engenders.

The rapid increase in the entrance of new players into the market arena in the past few months, as exemplified by the sharp increase in the ranks of online traders, is a warning bell for all to heed for it is at the end of trends when a mass influx of the uninitiated, lured by the smell of easy money, generally occurs. In recent months, as has occurred during past last-gasp-of-an-aging-trend runups in the major averages, there has been an alarming divergence between the buying and selling patterns of insiders (who have already made their profits) and the newly arrived.

Yes, yesterday momentum, complacency, irresponsibility, and speculative fever won out over reason for yet another day as technology stocks in general, and Internet stocks in particular, powered the market ever higher. While we have said in the past that such mundane matters as historical valuation levels, or even technical analysis do matter, we will concede that at this point they temporarily can be disregarded, but only in the short term.

When speculative sentiment driven momentum reaches an extreme fever pitch fundamental analysis and technical analysis cease to be effective in the short term. It is the mind of the crowd alone that drives the market and the crowd becomes consumed with furthering their aims at any cost. It is the focus on the short term that allows the collective mob to drive prices ever higher because only the next day matters. Financial cable networks in need of a daily dose of sound bytes, market guru analysts who have been forced to drop the word sell from their ratings system, and chat room participants in need of camaraderie only help to foster this increased focus on the short term. The crowd loses sight of the long term, until they are forced to confront it face to face and historical methods of determining fair value, whether they be fundamental or technical, once again come into play.

Yesterday's frenzy for Internet stocks continues to point to a market that has succumbed to mob rule at the expense of sanity. In a market driven by an extreme of sentiment, price targets set by mob annointed market gurus become self fulfilling prophesies, as was the case yesterday when priceline.com gained 37% to reach its $120 target price in one day. Even if priceline.com meets all of the rosy forecasts for its future, its current valuation levels discount all growth many years into the future. An investor with his mind on the short term hype but holding for the long term is unlikely to see an appreciation of his investment for many years to come.

Today will likely see more of the same as the market reacts to better than expected results from auctioneer eBay while overlooking the fact that this tiny company with $34 million in revenues now has a market cap that is 50% greater than the combined valuations of Federated Department Stores and KMart, which between them have $49 billion in annual revenues. Whether eBay will ever achieve the combined revenues of these two retailing giants is anyone's guess, but with the distance between hope and reality so great any opinion or analysis made at this point is only a guess. Buying stocks only on a guess never works out to the plus side over the long term.

Last week ended with complacency and rampant speculation firmly in the driver's seat after having successfully beaten back an attempt by reason to prevail.  The market froth index, a.k.a. the Goldman Sachs Internet Index, ended the week up 3.4%.  Our own Tulip Index ended the week up 3.7 to 59.1, a gain of 6.68% on the week (compared to 26.4 in January).

We are likely to see a further expansion of the Internet stock bubble this week. Today a Goldman Sachs analyst (in a report inadvertently released on Friday) set a $120 price target for recent IPO priceline.com, a figure which would give the company (which in 1998 recorded $35.2 million in revenues and $114.4 million in losses) a market cap of $17.1 billion. To be fair, the company's revenues are expected to grow to $300 million this year and it is branching out beyond its original focus on letting consumers set their own prices for airline tickets (see the press release issued by the company this morning titled "How Big Is Priceline.com"), but at $120 a share priceline.com's market cap would exceed the combined market caps of airlines AMR and UAL, which together had $36.8 billion in revenues.  Either the demand for airline tickets is about to explode upwards, or something is rotten in the state of Denmark (feel free to substitute the words "New Paradigm Valuation-land" for "Denmark" in this sentence).

The annual Hambrecht & Quist technology conference, and earnings reports due from Internet shining stars Amazon.com (substitute the words "expected loss" for earnings here), eBay, DoubleClick (reread our Amazon.com phrasing guidelines), and S&P 500 member America Online will likely give the chat room fueled bubble further opportunity to ascend to new heights of valuation extremes this week.

Beyond the bubble, for those of us who still hold to the quaint pre-New Era, pre- Goldilockian Era notion that there is a correlation between the stock market's valuation and actual economic performance (as opposed to the current New Era way of thinking where a public relations person's spin on future events yet to come determines valuations), this week will present a full slate of economic news for the markets to digest.

We would keep a close eye on today's meeting of G-7 finance ministers in Washington.  While hope has led the Nikkei higher this year, the actual economy remains in dire straits and at risk of a further slowdown.  We expect the G-7 ministers to emerge from the meeting with new plans to stimulate the Japanese economy.  For the global economy's sake, let's just hope that what emerges is a feasible plan and not yet another plan for unneeded public works spending.

We would also keep an eye on the release of Japanese Household Spending figures on Friday.  A weak showing in this report could seriously damage the belief that the Japanese economy is on the mend and lead to a global market selloff.

In the U.S. this week we would pay particular attention to Wednesday's Durable Goods report to see whether last month's weakness was a one-off fluke or an indication of actual developing economic weakness.  Thursday's Employment Cost Index, and Friday's release of first quarter GDP also bear watching, although we expect no surprises from either report.