Dow Stumbles but the Comp Keeps Its Feet

Into every rally a little rain must fall, and a steady drizzle today cooled off that previously red-hot index, the Dow Jones Industrial Average.

The Dow fell 1.5%, owing to weakness in consumer-sensitive names such as Home Depot (HD Quote) and Procter & Gamble (PG Quote), as well as defensive plays 3M (MMM Quote) and United Technologies (UTX Quote).

Following the Dow's lead, the S&P 500 slid 0.7%.

Given the recent gains, today's setback was unlikely to have caused much consternation among most market watchers, who continue to favor Old Economy names, as reported at midday.

"Short-term trends point firmly up, and while this rebound should be at least in part retraced in coming sessions, previous recovery peaks are now targeted again, eventually," commented Steen Jacobsen and Jeffery Lins of Saxo Bank in Denmark this morning. (More on that in a moment.)

The S&P 500's recent peak was at 1177 on Jan. 7, and the Dow appears to have hit technical resistance at it approached its early August highs just above 10,600.

Meanwhile, the Nasdaq Composite continued to exhibit relative strength, rising 0.4% today, largely thanks to strength in semiconductors. The Philadelphia Stock Exchange Semiconductor Index rose 2.2% to 613.90, outperforming both the overall market and big-cap tech as well; the Nasdaq 100 gained just 0.3%.

The SOX is benefiting from its ability to hold technical support at 500 last week and more recently climb above 600, which is where the index faltered in early January. Its climb above those levels suggests potential upside to around 660, from where it broke down in early August. That's according to John Roque of Arnhold & S. Bleichroeder (and RealMoney.com), who was admittedly caught wrong-footed when the SOX didn't break through that support near 500 late last week.

Myriad fundamental reasons helped spur chips higher today, including solid guidance from Texas Instruments (TXN Quote) and a Morgan Stanley upgrade of Intel (INTC Quote).

Also, the Semiconductor Industry Association reported that industry sales decreased in January on both monthly and year-over-year basis, but forecast double-digit growth in the second half of the year, and cited a continued rise in DRAM prices and growth in microprocessor sales.

The trade group also spotted "growth trends in the Asia Pacific market" due to "continued outsourcing to contract manufacturers located in the region," which supports anecdotal evidence from other sources.

"We're hearing some contractors that build [semiconductor fabrication plants] are seeing improving trends," said Tobias Levkovich, U.S. equity strategist at Salomon Smith Barney. "Many companies shelved 300 millimeter projects, but in the last two-three months the phones have been ringing at contractors, which is a precursor we've hit an order bottom."

Levkovich is bullish on Intel and on chip equipment manufacturers such as Applied Materials (AMAT Quote) and Novellus Systems (NVLS Quote), but remains more optimistic about the Dow and S&P 500 vs. the Comp, as reported at midday.

"We worry about valuations, and [the Comp] is where the high valuations are," he said. "Certain parts of the Nasdaq are appealing, but it's hard to make a grand argument for communication chipmakers and telecom equipment because there's so much excess capacity and they're tied to wireless spending. I don't know how to get [those groups] going if [capital expenditures] go down."

Levkovich suggested a big trend in 2002 is going to be a shift away from style -- big cap vs. small, growth vs. value, etc. -- and toward company-specific fundamentals. Certainly that's how it should be. But the conventional wisdom among those still practicing style investing is that investors should pile into Old Economy cyclical and consumer names that have already had big gains. That strikes us as another example of prognosticators' tendency to extrapolate the past rather than truly look forward.

As one hedge fund manager put it, "Obviously, there seems to be rotation out of consumer [stocks] into cyclicals, but if the economy is really turning, there's a lot more leverage in tech than in cyclicals."

Lurking Skeptics

As mentioned above, few optimists were likely surprised or overly concerned by today's setback for the Dow and S&P. But some hardcore skeptics found the setback an opportunity to reassert concerns that yet another "sucker's rally" is all we're experiencing.

"I have never seen a bear market coming to a conclusion when everybody and their mother (from Denmark!) wants to be invested in U.S. equities," said Ike Iossif, president of Aegean Capital in Chino Hills, Calif., who passed along the aforementioned Saxo Bank report.

Iossif described himself as "open and flexible" and not married to any one viewpoint (which in this case would be the bearish one). "In the interest of objectivity, I'd be willing to consider that maybe things have changed, maybe this time is different," he wrote. "However, if this time is not different, then the optimists are in for a big surprise and a very rough ride."

In a similar light, Woody Dorsey, president of Market Semiotics in Castleton, Vt., commented today that "it is necessary for the current drama that a hopeful scene unfold before a real catharsis on the downside."

Dorsey forecast that the market will hit an intermediate-term bottom sometime in the second quarter or possibly in the third, noting "the biggest declines come at the end" of bear markets, even if they are short-lived. "We expect and would like to see a more complete recovery [of] complacency into early April to set up a significant disappointment."

That is to say, this rally will prove to be like all others since the market's peak in early 2000.