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Mid-Week Analysis

Russell 2000 Index
S&P 400 Mid Cap Index
Semiconductor/SOX Index

Apart from the wild volatile world of technology stocks, U.S. equity markets are uncharacteristically quiet so far for this option expiration week. The Dow, S&P500, Transports, and Morgan Stanley Cyclical index are all basically unchanged for the week. Defensive stocks have under performed, with the Morgan Stanley Consumer index and the Utilities declining about 2%. The small cap Russell 2000 and the S&P400 Mid-Cap indices have added about 1%. Technology stocks rallied strongly today, pushing the NASDAQ100 to a 2% gain for the week. The Morgan Stanley High Tech index has increased 3%, The Street.com Internet index 2%, and the Semiconductors 9%. The NASDAQ Telecommunications index has declined 2%, while the Biotechs have given up 1%. Bank stocks are largely unchanged, while the Security Broker/Dealers have declined about 1%. Gold stocks are have dropped 2%.

With evidence accumulating that the economy bounced back smartly in January, selling pressure has developed in the credit market. So far this week, 2-year Treasury yields have added 21 basis points to 4.85%, the highest since early January. Five-year yields have returned to 5%, increasing 19 basis points. Ten-year yields have added 13 basis points, while the long-bond yield has increased 6 basis points. Yields on benchmark Fannie Mae mortgage-back securities have jumped 19 basis points, while agency yields have increased about 12 basis points. The 10-year dollar swap spread has increased four basis points to 97. Constructive economic news has generally benefited the dollar, with the dollar index posting a small gain so far this week.

With more than six weeks of trading in the history books, it is worth taking a look at year-to-date performance in various groups. Clearly, there is considerable indecision as money managers jockey to get positioned in what they hope to be the hot groups. At this point, it looks like current fundamentals are not the overriding factor in what is another round of “The Money Game.” So far for 2001, it looks like an appetite for risk is returning, as the more speculative stocks and markets have generally come out of the blocks strong. At the same time, the bluechips have been unimpressive, with the Dow and S&P500 largely unchanged. The economically sensitive issues have outperformed, with the Morgan Stanley Cyclical index and Transports adding 2%. The “defensive” stocks have been under pressure, with the Morgan Stanley Consumer index dropping almost 4%. The Utilities, last year’s highfliers, have declined 7%, although still sport a 52-week gain of 31%. And while the perception is that NASDAQ and technology stocks have been under selling pressure, this is not really the case. Despite recent weakness the major averages sport impressive gains. Year-to-date, the Morgan Stanley High Tech index has added 6%, the NASDAQ Telecommunications index 4%, The Street.com Internet index 10%, and the Philadelphia Semiconductor index 18%. Financial stocks have generally performed well also, with bank stocks up 3% and the AMEX Securities Broker/Dealer index up 5%. The Broker/Dealer index has a 52-week gain of 41%.

The S&P600 Small Cap index has gained 6%, and the Small Cap Russell 2000 index added 4%. The S&P400 Mid Cap index has gained 1%, with a 52-week gain of 18%. Biotech stocks, last year’s big winner, have had a rocky start declining 8%. Interestingly, the S&P Retail Stores Composite Index has gained better than 4% and is now 25% above trading lows set in Mid-October. However, the leading S&P industry groups are “Telecom-Long Distance” up 25%, “Entertainment” 23%, “Office Equipment & Supplies” 23%, “Retail Department Stores” 19%, “Toys” 18%, “Auto Parts and Equipment” 17%, “Leisure Time” 16%, and “Photograph/Imaging” and “Housewares” 15%. It doesn’t look like the stock market is all too concerned about recession.

International markets are mixed, although it is becoming apparent that money managers are ready to return to the emerging markets. Latin American markets have been very strong, with the Mexico Bolsa and the Brazil Bovespa indices both up more than 12%. The Argentina Merval index has surged 19%, Venezuela 13%, Peru 9%, Columbia 18% and Chile 1%. Up North, Canadian stocks are largely unchanged. Across the Atlantic, the London FTSE 100 has posted a slight decline, while the Paris CAC40 has a loss of almost 5%. The German DAX has added about 1%, while the major Italian index has jumped 7%. Major indices in Spain are down about 3%, the Amsterdam exchange has dropped 3%, and the Swedish market (hit by a 14% decline in telecom giant Ericssson) has dropped 6%. And while the protracted bear market continues to thrive in Japan with the Nikkei suffering a 4% decline, stocks in Asia are quietly posting strong gains. Even the Japanese JASDAQ (top 100) has gained 14% year to date. Elsewhere, the Hang Seng in Hong Kong has added 5%, and the Australian All Ordinaries has gained 4%. The major index in Taiwan has surged 24%, South Korea 20%, Thailand 17%, India 10%, Philippines 13%, and Malaysia 5%.

With today’s 8% gain in the Semiconductor stocks, it is worth mentioning yesterday’s earnings release from industry leader Applied Materials (AMAT). The company reported earnings for its first quarter of $0.66, beating previously guided down estimates of $0.62. That is about the only positive from this report, with AMAT badly missing revenue forecasts while also making some quite negative comments on the quarter and the coming year. AMAT revealed that it experienced significant pushouts and order cancellations, with orders declining 33% sequentially. AMAT also stated that it expects that semiconductor capital spending could drop 20% this year. PC, telecom, and foundry customers represented the majority of the terminated and postponed orders. This should not have come as much of a surprise with these sectors having been under pressure for several quarters. Management also disclosed that some of its smaller customers where deferring all 300mm plans. The upgrade cycle to 300mm wafers has been one of the key aspects of the recent capital-spending boom.

While most Wall Street analysts are in agreement that the cycle will bottom over the coming months, as the second half of the year shows improvement, it was the aggressive call from J.P. Morgan's chip analyst, Eric Chen that is being attributed to today's rally. According to Chen, “the worst is known, and could be behind us soon.” While it appears that the market did take note of Chen’s comments today, a report with a somewhat differing opinion from Bank of America went ignored. The BofA report made the key point that the semiconductor industry is presently using the 1995 and 1997 downturns as templates for the current downturn. B of A went on to point out that the turbulence in various end markets (PCs, cell phones, Internet infrastructure) sets this cycle apart from those of the past. Thus, investors shouldn’t be surprised if things turn out differently.

We are amazed that no other analyst addressed this idea. It just shows how ingrained the notion that any sort of technology downturn can only last a few quarters at most. Ironically, complacently deepens in the mist of a potential debacle in the newest cell phone technology, 3G. We would like to remind everyone that there is still a situation of over-capacity. Taiwanese foundries are now running only 70% of capacity. It will be interesting to watch the technology sector in the coming weeks and months as the industry waits anxiously for what it sees as an inevitable recovery. We wouldn’t hold our breath.

As usual, Greenspan’s testimony yesterday had something for everyone. It was rather entertaining to see the various headline’s: The New York Times, Greenspan Says Slowdown Could Be Brief but Acknowledges Risks, The BBC Greenspan warns on US economy, Reuters Greenspan: Economy Not in Recession, The Washington Post Greenspan Mildly Optimistic, San Francisco Chronicle Greenspan Changes Tune. From our listening and reading of the Fed Chairman’s testimony, we think Bloomberg had the most accurate headline with Greenspan Says U.S. Probably Will Avoid Recession Amid Productivity Gains.

Trying to be objective, we just don’t see the recession-type data currently. From today’s MarketNews International Reality Check column: US Spirits Manufacturers See Sales Rebound First Quarter ’01. The story begins, “U.S. spirits manufacturers say they’re seeing signs of a first quarter rebound from a fourth quarter lull, along with the ‘best pricing atmosphere in years’ from a sellers standpoint…In practically all categories of spirits, higher-priced premium brands continue to drive the market…”An owner of a Napa Valley winery was quoted as saying “we have not experienced a slowdown at all. In the last six months we’ve seen stronger demand domestically and in our export markets in Asia and Europe. An executive from Mondavi stated: “Where the growth rates were 20% six months ago, they’re currently at 10% - but how many industries are growing at 10% rates. He also stated that industrywide growth rates for wines above $9 remain at 20%. Marketnews also quoted an anonymous “beer executive” who stated, “anecdotally, I don’t think things are slowing down” and that “the pricing environment for beer is better than it’s been in past years.” Another industry observer stated, “what we hear anecdotally from wholesalers and retailers is that January got off to a good start.” “He also observed that currently all sectors – beer, wine and distilled spirits – are all enjoying growth, which is unusual in a market in which one tends to take away business from the other.” Sounds like one more major industry that has quietly gained pricing power.

Speaking of industries with pricing power, the American Petroleum Institute (API) reported that U.S. imports of gasoline, heating oil, other fuels surged to 2.923 million barrels a day, (according to Bloomberg) the highest since January 1990. From Bloomberg: “The 41% increase in imports from the same month last year highlights the country’s increased dependence on international supplies…the U.S. now relies on other countries to supply 60% of its petroleum energy needs, up from 29% in 1972 as domestic production of crude oil and products has failed to keep up with increased demand…imports of gasoline and its blending components were 19% higher than a year earlier…Jet fuel imports were up 52%. Also interesting, “total U.S. oil deliveries during January – a measure of U.S. demand – were 4.4% higher than a year earlier, the API said.”

Also today, Bloomberg reported on a two-year research report that forecasts 50% increase in global energy demand by 2020. Currently, the California energy crisis holds considerable potential for problems over the coming weeks. Canadian power generators are threatening to terminate electricity sales as large bills go unpaid. There are also several generators that are off-line due to maintenance or other problems. The State of California has already spent $1.5 billion buying power and Bloomberg reported today that “California Governor Gray David warned legislators that the state will need another $500 million to buy electricity this month.” What a mess…

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