New Week Brings Familiar Pattern

The slow but steady erosion of the postelection rally continues as another early breakout bid fails.
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Wall Street got socked by a blizzard over the weekend, but no one was on hand to witness its fury. The howling of the market's correction, however, has had plenty of witnesses.

Friday's ugliness just kept right on chugging through Monday's market. Without any grand earnings or macroeconomic news to turn things around, the markets started up on blind optimism that lasted about 30 minutes before giving way to creeping pessimism. What little good news was to be found, such as

American Express

(AXP) - Get Report

reporting earnings and revenue above expectations, were of help only to the specific issues.

American Express shares gained almost 2%, helping limits losses in the

Dow Jones Industrial Average

to fewer than 25 points, or 0.2%, for a close at 10,368.61 vs. its intraday best of 10,443.87. The

S&P 500

lost 0.4% to 1163.75, about 10 points below its session high. Safe havens performed well as the Dow Jones Utilities Index rose almost 1% and the yield on the 10-year Treasury note declined slightly to 4.12%.

The

Nasdaq Composite

just picked up where it left off last week despite the morning's up open; after trading as high as 2043.97, the index finished down another 1.3% to 2008.70. The Philadelphia Stock Exchange Semiconductor Index lost 1.7% and the Amex Internet Index dropped 2.4%.

The psychological Nasdaq 2000 barrier, last seen at the beginning of the Bush re-election rally, is in view once again. Experienced strategists are still looking for signs of panic before calling a turn in the market. Nasdaq volume rose on Monday from Friday even as the index set a new low for the year, a "good" sign in that view.

Kevin Marder, chief strategist at Ladenburg Thalmann Asset Management, was last heard round these parts two weeks ago warning that the correction had

further to fly.

Among the tendencies of a down market is a late fade. Monday's drop at the end of the day marked the 11th out of the year's first 15 trading days, Marder noted Monday. But, he said he's finally started to see signs of the kind of panic selling that mark the end of such a downward thrust.

"A 'good low' would ideally include a spike in bearish sentiment, panic-selling and a jump in volume," he wrote. Conceding that not all downturns end with such obvious signals, he argued that "the best trading rallies emanate from such."

The CBOE Volatility Index rose 16% last week and gained another 1% on Monday, showing some signs that investors are growing more worried. The put/call ratio also moved up to 0.9 last week.

The Great Dividend Debate

The consensus in favor of dividend-paying stocks is still building strength but has finally started to attract some contrarian attacks. Among those still building the consensus up are Lehman Brothers strategists Inigo Fraser-Jenkins and Ian Scott, who have been banging the dividend drum

for months. This week, they're out with a piece predicting a strong season of dividend increase announcements over the next two months.

Fifty percent of U.S. companies are expected to make dividend announcements by Feb. 19 and 75% by March 17, the Lehman analysts calculate. Sticking with their prediction of a 20% increase in dividends globally for the year, outpacing a 6% gain in corporate profits, they argue that dividends will be enough to sustain the stock market.

But former Wall Street analyst turned hedge fund manager David Jackson says the current focus on dividend payers is a mistake. He'd prefer to see companies buy back stock, which doesn't create a taxable event for shareholders the way dividends do, or invest more in their businesses.

He's especially wary of the argument that if there are fewer growth opportunities and the market is range-bound, dividends are the best use of cash for most companies. "If you think that growth opportunities are lacking and earnings won't grow, buy bonds instead of stocks," he writes. "They're less risky and your 'dividend' is assured."

One implication of the market's focus on dividends may be to favor put options over shorting marketing indexes, Jackson adds. Shorting a market index requires that the investor pay the dividends as a cost of carry while put options don't require payment beyond the initial premium. Because many companies are raising dividends in reaction to investors' clamoring, the cost of shorting indexes will go up. In theory, the prices of put options on an index include an assumption about future dividends, but the assumptions may not be keeping up with the hysteria, he says.

Jackson is shorting

SBC Communications

(SBC)

, the local phone giant, on the theory that dividend-hungry investors are helping jack up its price. Internet telephone services will hit SBC's bottom line and the dividend will eventually be cut, he argues.

On the other side, Lehman has compiled a list of stocks most likely to announce big dividend increases based on the ratio of current dividend rates to free cash flow. Four companies with a lot of cash flow don't pay any dividends yet:

Xerox

(XRX) - Get Report

,

PG&E

(PCG) - Get Report

,

IAC Interactive

(IACI)

and

Cisco Systems

(CSCO) - Get Report

. Others at the top of Lehman's list include

UnitedHealth Group

(UNH) - Get Report

and

Danaher

(DHR) - Get Report

.

With the bulk of announcements in the U.S. expected in February, that should provide a good test of the bull's thesis on dividends. The markets could use a boost. According to

The Stock Trader's Almanac

, the S&P 500 has averaged a loss of 0.1% over the past 54 years in February. Of the 20 times when stocks lost ground in January, the average for February was a loss of over 1%, or 10 times as much as the average February.

In keeping with TSC's editorial policy, Pressman doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send

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