MASTERING
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ORIGINAL, INTERACTIVE SEMINAR ON TRADING USING
TECHNICAL ANALYSIS 

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NASDAQ and the technology issues continued to soar on a wave of optimism, but the other major averages posted more subdued gains.  Breadth remained negative, with the Advance/Decline Line sinking to yet another new low.

Bullish analyst comments on the semiconductor sector and a favorably read  earnings report (and a 2 for 1 stock split) from acquisitive Internet company CMGI set the tech sector into motion on Thursday.

While the favorable spin given to CMGI's earnings helped lift the techs, the earnings themselves were a prime example that beauty is truly in the eye of the beholder. We'll have to admit that if we had only read the highlighted and bold sections of CMGI's earnings, then we too would have been rushing out to buy its stock.

CMGI's Internet operations did enjoy phenomenal revenue growth in the quarter, with revenues shooting up 352% sequentially to $85.1 million in the quarter. Of course, there are two sides to every story, and in this case, the other side of the tale was an alarming 422% sequential jump (to $277 million) in the operating loss of the company's Internet segment.

Now call us old fashioned, but there was a time when a loss-to-revenue ratio of 277-85 would not have been regarded favorably, and there was a time when investors looked unfavorably on the now commonplace sight of companies whose losses are growing at a faster pace then their revenues.

While we realize that soaring stock prices, and an avid pool of investors willing to send the prices of anything .com higher still, make the business model of  the New Era feasible at the moment, we question whether this model will be able to survive during a prolonged euphoria-free period.  We suspect that when the euphoria dies, the companies that have fed their growth through all-stock deals will see their growth rates slow dramatically, and we have a sneaking suspicion that many of the marginal Internet companies will be forced to learn the age old business secret that those who never turn a profit never see tomorrow.  But that's a story for another day...

Although CMGI and the tech sector helped the major averages to gains on Thursday, they could do little to prevent the interest rate sensitive financials from following the bond market down.

 Bonds dropped back to their lows of the year, with yields on the long bond hitting 6.39%, after more evidence emerged to reinforce that which was already known: the consumer's unquenchable desire to acquire has not ebbed, and the labor market has a noose around its neck.

The bond market plunged for the second time this week after October's trade deficit came in at a higher than expected $25.9 billion--another new record.  Imports set another record as the consumer continued to spend... and spend, with consumer goods and computers their acquisition of choice.

The trade deficit numbers, like the retail sales data earlier in the week, increase the pressure on the Fed to either act now to curb demand or risk falling behind the curve.

The latest Initial Jobless claims numbers also raise a red flag. The four-week moving average of claims fell 5,250 to 282,000--the last time the 4-week average was at 282,000, Richard Nixon was President.  The four-week moving average of seasonally insured unemployment (think of this number as one measure of the pool of available workers) fell 13,500 to 2.1175 million. 

The jobless numbers indicate that the labor market continues to tighten.  With the Fed meeting only days away, the two factors (unsustainable economic growth and an extremely tight labor market) which caused them to raise rates at their last meeting have begun to show signs of accelerating.

A benign CPI report provided little solace for traders on Tuesday after stronger than expected retail sales numbers reignited fears that surging consumer demand will force the Fed's hand at its February meeting.  Bonds tumbled, with yields on the 30-year long bond soaring to 6.30%.

The prospect of higher interest rates rattled investors in the stock market's frothiest sectors. The NASDAQ Composite tumbled 86.50 on the day, the semiconductor index (SOX) fell 6.8%, the GSTI Internet Index lost 5.89%, and the CBOE Technology index ended the day down 2.7%.

Breadth continued to be miserable, with decliners leading gainers by a 2 to 1 margin on the NYSE, and new 52-week lows swamping new 52-week highs 579-58.

While the recent euphoric momentum driven surge by the major averages has allowed concerns over rapidly deteriorating market internals to be brushed aside, we would expect any abatement in the current euphoria to once again turn the focus towards the underlying state of the market--a state which is anything but pretty, with 56% of stocks in long term down trends, 53% in intermediate term down trends,  and 60% in short term downtrends.

Two indicators in particular point out the sharp divergence between the markets haves (the minority) and have nots (the majority).  The cumulative 4-week new hi-new low index has sunk to a 2 1/2 year low, and the advance/decline line's decline has accelerated rapidly even as the NASDAQ's rise accelerated.  The A/D line finished Tuesday at its lowest level of the decade, and has been declining since April 1998.  The divergence between the trend of these two indicators and the trend of the major averages highlights the fact that for the average stock, the past year and a half has been anything but a bull market.

While the general perception is that the entire market is deeply overbought, in reality there are actually more stocks that are oversold: 28.0% of stocks are oversold, while only 9.5% of stocks are overbought. While at first glance these numbers may seem like a buying opportunity, the truth couldn't be farther from the fact.  Although there are 3 times more oversold stocks than overbought ones, it matters little because the vast majority of the money flowing into the market has gone into the narrow group of overbought stocks--and therein lies the danger.

The concentration of the money inflows in a narrow basket of stocks, when combined with the euphoria that has accompanied those inflows, leaves the market in a precarious state--a state where euphoria and complacency must be maintained in order to prevent a bloodbath.  While a large segment of stocks may be oversold, they are unlikely to escape the effects of any reversal of market sentiment.

Today's sharp selloff in technology and Internet stocks did not mark the end of euphoria, and thus did not signal that a sharp market reversal is at hand, but it did perhaps send a signal that euphoria has reached a plateau.  The market's attention will shift once again from a myopic fixation on the technology sector to a dual focus on both the market's 'hot' sectors and the Fed's next move.

The market will once again hang on the release of each tidbit of economic data--in short, volatile swings both ways will increase.

Today's CPI and Retail Sales numbers presented little in the way of new news: inflation remains low and consumer demand has yet to be effected by this year's runup in rates.

Headline November CPI came in below expectations at 0.1%, with core CPI registering a gain of 0.2%. The underlying numbers were generally favorable, with food and energy prices remaining stable to down on a month to month basis.  Of course stable food and energy prices do have their downside: a consumer whose day-to-day living expenses are stable and who has a pocketful of cash derived from his rising portfolio of tech stocks is unlikely to feel compelled to curb his spending.

The one negative in the CPI report, and one that will likely catch the Fed's eye, was medical expenses.  Medical care expenses increased 0.4% in November, with prescription drugs increasing 0.6%, and hospital/medical care costs increasing 0.3%.  To a Fed that has expressed concern at the recent pickup in benefit costs in the midst of the current tight labor market, the numbers will sound a minor warning bell.

The Retail Sales numbers, which came in with a much stronger than expected gain of 0.9% (October numbers were also revised higher, to a gain of 0.3% in the headline number and 0.8% ex-auto), will wave a red flag in front of the Fed.  Particularly troubling in the numbers were sharp gains in interest rate sensitive building materials (up 0.9%) and durable goods (up 1.5%).  It should also be remembered that the sharp gains in the headline number came despite the fact that warm weather slowed sales at many retail stores during the month.

All in all, the bond traders had a very good reason to run for cover after the release of the report.  The Fed has repeatedly expressed its concern that soaring demand and above trend economic growth, when coupled with tight labor markets, will lead to trouble down the road.  Today's numbers point to fourth quarter GDP of 5.5%-6%--not exactly the sort of economic growth rate that will allow the Fed to stand still for long.

Finally, in an unrelated note, many of you are aware that we moved the main Tulips and Bears web site to a new server over the past week.  Now, moving a web site the size of this one is similar to moving your home--with one notable difference: all of the boxes have to be unpacked on the first day.

Naturally, there were some glitches along the way.  A broken telco router leading to our old server made it unreachable from the net for 12 hours early Saturday morning and set us back a day.  Granted, a certain e-commerce auction house has stated that it has the cure for unforeseen technical problems, but in the real world, outside of the land of sweet-talking for the analysts, there is no cure for the unexpected technical problem-- it comes with the territory and is an inherent risk for all  companies that do business on the Internet.

Of course that wasn't the only problem.  a component shortage means we'll be temporarily running the site on a pair of Pentium 111 500's and with 512 less megabytes of RAM than planned until our shipment of Pentium 600's and additional RAM comes in "sometime in the next two weeks".

Internet Mania, IPO Fever, the Wonder of Linux, and a reaffirmation of the reign of  Goldilocks gave traders a reason to smile on Friday. The NASDAQ Composite hit another  record, another IPO popped up 200 points on its first day of trading, nary a bear was to be  seen, and not even midday rumors of an exchange-led push to raise margin requirements could  derail the freight train to the Land of Inflation-Free Technology-Driven Bliss.

The smiles aren't just limited to the trading floors and Internet day trading chat rooms, from sea to shining sea, from Wall Street to Main Street , smiles abound and not a jitter is to be felt in the wake of Friday's benign Producer Price Index numbers.  Inflation is low, growth is strong, jobs are plentiful, the stock market continues to amaze, and the belief continues to grow that the age of Goldilocks will stretch far into the new millennium.

By focusing on current conditions and projecting today's environment into the future, investors have created a world where the future is only limited by the imagination and the present knows no bounds.  The potent mixture of euphoria and momentum pervades all, allowing the bad to be overcome and the good to be celebrated.

While day traders may have grabbed the media's attention, it is on Main Street, in the land of the 4-Wheel Drive, the 401K and the Long Term Outlook, where the belief in future prosperity and a perpetually rising stock market is brightest.  The latest poll by the American Association of Individual Investors presents an almost uniform front of bullishness, with 62% of respondents bullish, and only 11% bearish.

The higher the market rises and the longer the duration of its rise, the more convinced investors become that the trend will continue--and the more convinced they become, the more money they pump into the market's best performing sectors.

This week, by virtue of focusing on present conditions rather than potential future conditions, we expect investors to push the market higher on a belief that last month's benign data precludes malignant future data.  Tomorrow's CPI report, which we expect to show no surprises, is likely to give a further boost to sentiment and share prices as investors continue their 7-month old habit of mistakenly attempting to predict the future course of interest rates based on the rosy picture painted by the current low inflation high growth environment rather than by focusing on the probable future environment that today's above trend economic growth rates and increasingly tight labor market will create.

Momentum and euphoria will continue to push stock prices higher in the short-term, but as any elementary school student knows: gravity exists, and as any pre-schooler will tell you on the day after Santa comes: even euphoria has its limits, and the downside is always a let-down.

Going forward, we see two events that are likely to stop the market's current rise and burst the bubble of euphoria--two events that we have already seen repeated many times this year.  

The first event will be the upcoming earnings season.  The upcoming fourth quarter earnings season is likely to be a repeat of the second quarter's experience: mass pre-season euphoria turns into selling on the news.

The second event will be the market's realization that while it was focusing on the current inflation picture, the Fed was focusing on the demand side of the equation.

It will be at this point that those omnipresent "ugly market internals" and "severe case of bad breadth" come back to haunt the market.

Coming up in Tuesday's column: CPI analysis, the strong dollar and its effect on upcoming earnings, the Utilities, Linux, a broken router,  a pair of breadth indicators, and more.