Ebb and Flow Ends With Rising Tide

'You could paint a pretty ugly picture here,' says one observer, but major averages eke out modest gains.
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"I'm just sitting here watching the battle between light and dark," Raymond James' chief equity strategist Jeff Saut quipped Thursday when I asked how he's doing.

Light and dark battled it out on several fronts Thursday. Dark seemed to be winning when we spoke around 2:00 p.m. EDT, but light won the day -- at least in the major stock market indices.

That said, tensions between Iran and the West escalated, rather than moving toward a peaceful resolution. The U.S. Senate passed a war-spending bill that puts the legislative branch on a collision course with President Bush, who has threatened to veto any bill that includes a deadline for withdrawing American troops from Iraq. Oil closed up another $1.95, or 3%, to $66.03 per barrel.

"You could paint a pretty ugly picture here," says Saut, who recommends a defensive 30% cash position. "I keep hearing people say, 'This is a buying opportunity.' But what if this is a selling opportunity?"

Indeed, the bears were beating stocks down midday after an early spike on a modestly upward revision to fourth-quarter GDP and unexpected drop in weekly jobless claims. After gaining as much as 80 points intraday, the

Dow Jones Industrial Average

spent much of the afternoon in the red. The index then clawed back to positive territory by the end of the day to gain 0.4% to close at 12,348.75. The

S&P 500

finished the day up 0.4% to close at 1422.53, and the

Nasdaq Composite

finished up a fraction to close at 2417.88.

Traders warn that this week's moves are somewhat off-kilter due to quarter-end window dressing. So even while stocks ended on a high note, sentiment seemed glum.

The semiconductor sector was suffering Thursday at the prospect of weak profits.

RF Micro Devices

(RFMD)

and

ATMI

(ATMI)

gave weak first-quarter earnings guidance, sending the stocks down 10.8% and 6.8%, respectively.

The news dragged down many in the chips arena, as

Broadcom

(BRCM)

, and

Advanced Micro Devices

(AMD) - Get Report

fell 0.7% and 2.2%, respectively, while the Philadelphia Stock Exchange Semiconductor Index lose 0.9%.

Other firms issuing warnings or weak results included

Nabors Industries

(NBR) - Get Report

, which bucked the uptrend in energy names, and

UTi Worldwide

(UTIW)

. Insurance stocks were also notably weak after UBS downgraded

United Health

(UNH) - Get Report

, which fell 3.5%.

Bond prices nudged lower, but yields remain essentially flat on the day and the curve somewhat steeper.

Utilize This

Many strategists and economists harkened back to

Federal Reserve

Chairman Ben Bernanke's testimony Wednesday to the Joint Economic Committee to back up their own concerns about earnings. Bernanke highlighted high levels of resource utilization and rising labor costs putting pressure on companies' profit margins -- particularly if productivity does not keep pace or if consumption slows. In other words, if companies have to pay more but can't pass along those costs, their profit margins will shrink.

Northern Trust chief economist Paul Kasriel agrees that the Fed should take note of declining profits. While the Commerce Department revised fourth-quarter GDP up to 2.5% from 2.2% Thursday, it revised profits (before tax and adjusted for inventory valuation and capital consumption) to show a sequential decline through 2006, he notes.

"With volume growth slowing and labor costs rising, it is no wonder that profits growth is now struggling," writes Kasriel. "It is doubtful things will turn around soon unless

Circuit City's

(CC) - Get Report

plan to effectively cut the salaries of many of its employees becomes the norm." (On Wednesday, the electronics retailer fired 3,400 workers -- namely its highest-paid -- in an effort to cut costs and improve profits.)

Wall Street initially cheered the revised fourth-quarter GDP report, but traders soon realized that it wasn't all good news, not to mention relatively old news. On the upside, the Commerce Department reported inventories, and the trade deficit and government spending added more to GDP than prior estimates. Personal spending was unchanged, and equipment and software spending and residential construction were revised lower. Commercial construction finished higher.

The weaker business spending underscores Wednesday's weaker-than-expected report of durable goods orders as well as Bernanke's comments. Indeed, many noted Wednesday that Bernanke's subtle tilt toward neutral may have come more from concerns about business spending than from the ubiquitous housing woes.

In his testimony, Bernanke notes the Fed has observed softening in demand for other capital goods than those related to housing and auto industries. "The magnitude of the slowdown

in spending on capital equipment has been somewhat greater than would be expected given the normal evolution of the business cycle," reads the testimony.

But of course, the market also couldn't go a day without obsessing about the subprime sector. The Mortgage Bankers Association's mortgage applications index did increase in the week ended March 23, but there was a corresponding gloomy analysis to go with it.

Many economists say mortgage applications data is a leading indicator and has pointed to stabilization in the housing market. Mortgage applications for purchases bottomed in October 2006, according to the MBA index.

But Goldman Sachs economist Jan Hatzius says the data might be distorted "and might have lost some of its usefulness for forecasting housing activity." For one, applications are just that -- applications. Amid tightening lending standards, applications may not turn into originations, because rejection rates are likely to increase.

Also, the index underrepresents subprime lenders, says the Goldman economist. For those failing mortgage lenders that are represented in the index, the methodology immediately ignores those that go out of business, go bankrupt or stop giving out mortgages. So increasing failures in the mortgage lending business may actually help boost the index because dropouts are not accounted for, writes Haitzus.

So while the sun did come out in the afternoon, the battle likely resumes tomorrow.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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