Rumors Run Down Cisco and Roil the Market

Sometime this week, somewhere, rumors began that Cisco (CSCO Quote - Cramer on CSCO - Stock Picks), an Internet infrastructure company and the market's two-ton elephant, would miss earnings estimates when it reports Tuesday. Exacerbating this was chatter about massive buying of Cisco put options (a bet that a stock is going to drop). Wednesday, the talk, especially the former, gained leverage, and the stock was slammed, bringing down tech with it.

Thursday morning was horrible. After Cisco lost 7% of its value the previous two days to close at 60 15/16, the stock was killed at the open, falling 2 7/16. Initially, the decline was attributed to worries about second-half growth out of Motorola (MOT Quote - Cramer on MOT - Stock Picks), but traders saw it differently.

"The opening felt pretty lousy," says Matt Johnson, manager of Nasdaq trading at Lehman Brothers. "It was these crazy Cisco rumors about a Cisco miss, or that it would make a big acquisition in the optics market ... and the market just got to a point where it was way oversold."

It says a lot about the market these days that an unsubstantiated rumor can knock a stock down and run roughshod over the entire market -- as it did for nearly two days.

And it says something when a first-tier name, a company whose management Wall Street usually implicitly trusts to match quarterly expectations, comes under fire. Especially when it's Cisco, which has never warned on earnings over the past five years, according to earnings tracker I/B/E/S. (Five years is as far back as I/B/E/S' records on warnings go.) The First Call/Thomson Financial consensus estimate for Cisco's fiscal fourth quarter calls for earnings of 15 cents a share.

"In a vacuum, a rumor is as good as anything else," says John Bollinger, president of EquityTrader.com. "I think we're lacking a strong consensus view and therefore much more vulnerable to noise in general, of which rumors are but one aspect."

Maddening Month Cisco's rough ride astride rumors

What first shook up Cisco's stock was talk of massive put buying. Monday, in a huge block trade, someone bought 42,000 September put option contracts on Cisco -- the equivalent of 4.2 million shares. That trade accounted for 77% of the volume in those particular contracts Monday.

Investors generally buy puts, which give them the right to sell the stock at a fixed price at a certain time, as a bet that the price will drop, or they'll buy puts to hedge their bets if they're long. Word of the massive put volume didn't filter out until Tuesday, when Cisco first slumped. The weakness carried over to Wednesday, when the earnings rumor really asserted itself.

"A lot of the guys out there were kind of ticked off that some pretty heavy rumors on Cisco caused a lot of hair-trigger reactions, of people dumping Cisco," says Phil Ruffat, vice president at Fuji Futures in Chicago.

With traders sensing the rumor was bogus, the stock rebounded Thursday to finish up strongly, and analysts have defended the stock in comments over the last couple of days.

Restlessness Rules

August isn't a busy time. Earnings season is at a close, and people take vacations. With less trading comes the possibility of more volatility.

Right now, the market is suffering from a dearth of direction. Sentiment has reversed itself several times this summer, and though there remains a long-term belief in the strength of this bull market, the tone in the Nasdaq remains mildly bearish.

"I think it's the psychology of the marketplace," says Steven Goldman, market strategist at Weeden in Greenwich, Conn. "There's a lot of agitation out there; there's a great deal of concern."

But there's also enough optimism to keep this market going nowhere. The meandering action is frustrating for restless investors, and the desire for something to push the market in one direction can get rumors started.

"If you want a negative opinion on whole market, attacking Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks) alone is not going to do it," says Ruffat. "You have to attack someone else like a Cisco. You need to dump the infrastructure stuff, or otherwise, the Nasdaq's not going to go down."

But Cisco's stock price has lots of friends when it's in low places. The stock rebounded from a technical support level (sub-60), and finished smartly yesterday. Its rise from the ashes was central to yesterday's tech rebound. The stock has traded higher today as well.

While Cisco's ability to weather damage has proved to be supportive when the Nasdaq is reeling, the stock hasn't been able to take the reins and lead the market higher in the summer. Positive rumors haven't buoyed the Nasdaq as much as negative rumors have hurt it. Part of that's due to market sentiment. Part of that's human nature.

"Pain is a much sharper emotion, so when people get hurt by a negative rumor they yelp very loudly," says Bollinger. "But when people get treated to a positive rumor, they may just retire to the bar and celebrate quietly."

Which emotion comes next week? While estimates are for 15 cents a share, traders say the whisper number is 17 cents. Ruffat doesn't think for a second that Cisco will miss estimates, but unsteady market psychology has him wary of the whisper stories.

"We're expecting 15 to 17 a share, depending on who you listen to," says Ruffat. "But what happens if it reports 16 or 17? Does this make somebody say, 'Gee, look, they missed the whisper number?'"