Despite Recent Storms, Nothing Rains on Analysts' Sunny Market Predictions

SAN FRANCISCO -- The Kinks, Van Halen, David Bowie, Charlie Musselwhite and Si Kahn all dropped by for a visit today. We had a great jam session (once Bowie and Ray Davies stopped bickering over who would sing lead), but nobody could answer the overriding question of the day: Where have all the good times gone?

The Dow Jones Industrial Average fell 0.6% Wednesday, saved from steeper losses by strength in financials and pharmaceuticals. Meanwhile, the S&P 500 shed 2.4% and the Nasdaq Composite Index tumbled 5.6%.

The Comp's decline was laid at the feet of Nortel (NT), which fell 28.9%. Nortel's indications of a slowdown in capital spending on optical-networking equipment exerted heavy collateral damage on JDS Uniphase (JDSU), Ciena (CIEN), Corning (GLW) and SDL (SDLI), as well as communication-chip makers Applied Micro Circuits (AMCC) and PMC Sierra (PMCS). The Nasdaq 100 tumbled 7.3% in response.

Meanwhile, the euro fell to another record low vs. the dollar and yen, as finance ministers attending the Group of 20 meeting in Montreal said nothing about the beleaguered currency.

I've been skeptical of late and pretty clear (haven't I?) that I didn't/don't think the fundamentals support a big rally, even if everyone is expecting it, even if this is the right time of year for it. For those convinced the market bottomed a week ago, recall many observers were similarly inclined on Sept. 21 and Oct. 12.

Many of you presume such skepticism means I think the market is heading down the sinkhole, which is untrue. I'm grateful to Todd Harrison (to whom today's lead paragraph is in homage) for crystallizing the trading range scenario, with which I'm mainly in agreement.

That said, I'm compelled to repeat a salient point made yesterday by a trader who's a longtime source.

Many investors who bought into the market's strength last week are now, or may soon be, sitting on losing positions, he observed. Given that many who bought last week did so on margin, a scenario featuring continued weakness could lead to "a capitulation of bigger proportions" than what's transpired thus far.

Today's ungluing bares out those concerns.

All About Nortel

"We think that what is occurring at [Nortel] is more of a valuation than a business issue," Steven Milunovich, technology strategist at Merrill Lynch, said in the company's conference call Wednesday afternoon (and repeated as much in a report later in the day). "To become more bullish on technology, we like to see more pessimism. To become more positive on tech, we want to see the optics space crater as the last sign of capitulation."

The irony in that statement is there wasn't a whole lotta pessimism coming from Milunovich or other analysts during Merrill's conference call. There was, however, a whole lotta love for a variety of companies by various Merrill analysts, for both underwriting clients and non. To wit:

• "We are still very bullish about the overall networking market going into 2001," said Michael Ching, who defended Cisco (CSCO).

• "We remain positive on Nortel" and believe this optical revenue shortfall is a "temporary issue," said Tom Astle, who seemed "reasonably confident" in the company's explanations. Astle suggested the capex concerns are overblown because optical-networking spending is moving into a "second phase," which will focus on the "lighting" of the fiber and require other products. The analyst did express some concern about JDS Uniphase (JDSU), one of the few bits of pessimism on the call.

• "Use weakness to get into the stocks," said Steve Fox, who defended Corning and Stratos Lightwave (STLW). "These companies will have excellent results going forward."

As I mentioned in the RealMoney.com Columnist Conversation, Merrill analysts also defended contract manufacturers such as C-MAC (EMS), Celestica (CLS), Sanmina (SANM) and Solectron (SLR), as well as chip makers like Applied Micro Circuits (AMCC) and Vitesse Semiconductor (VTSS)

Maybe Merrill's outlook will ultimately prove prescient, but I'd feel more confident if they'd warned about the "need" for capitulation in the optical space before the fact, rather than after.

Every Cloud

There was a silver lining in the Nortel debacle today, at least according to Walter Nightingale and Gary Farber, who manage a relatively new $3 million hedge fund and about $25 million in managed accounts at Seattle-based Nightingale & Farber Capital.

Telecom service providers are going to benefit from the inventory buildup of infrastructure products, whose producers (like Nortel) will have to lower prices going forward, Farber said. Lower infrastructure costs will help companies such as Verizon (VZ), Nextel Communications (NXTL) and Global Crossing (GBLX) post stronger-than-expected earnings even if revenue growth isn't spectacular, he theorized.

This outlook flies in the face of conventional wisdom, which says the service providers caused the inventory problems by over- or double-ordering from the Nortels of the world and have now cut back or eliminated their spending. Regardless, neither scenario seems particularly good for the optical-networking providers themselves.

Nightingale & Farber is long the aforementioned telecom names. I'll have more from the interview (my first with these particular managers) in the coming days.

Try It Again, Sam

Last night's poll sparked a flurry of emails. Thanks as always for the feedback, from which I've culled some additional choices for tonight (although I wonder if the exercise is now academic). Last night's winner makes a repeat appearance -- sort of like on Jeopardy. Part 2: Stocks will rally because... Seasonality: October is coming to an end and November is starting. Lowered expectations make actual results look better. A slowing economy will force the Fed to ease. Two things: Baby Boomers and Technology. None of the above.

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