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What a Week: Mixed Messages

Major averages fell but held at important support levels. Plus, an unpleasant surprise on taxes.

It was a week in five acts, as trading patterns swung high and low only to leave the major indices about where they started the week.


Dow Jones Industrial Average

broke below 10,500 for the first time in over a month but finished the week down just 0.4% at 10,558. The

Nasdaq Composite

swung as high as 2111.43 and as low as 2066.79 before finishing at 2087.91, less than 1 point down for the week. And the

S&P 500

lost 0.1% on the week to 1184.52.

Good news from







MDC Holdings


, among others, wasn't enough to outweigh bad news from

General Motors



United Parcel Service


, and

King Pharmaceuticals



At the same time, economic news also was mixed. The November trade deficit set an all-time record of $60.3 billion and mortgage applications continued their decline. On the plus side, producer prices dropped, retail sales gained and industrial production rose.

Technically speaking, the indices were able to find and hold support levels despite intermittent selling throughout the week. The Nasdaq twice bounced sharply higher after crossing below 2070, close to the uptrend line that began with the October 2002 bottom. The Dow twice bounced near the 10,500 level and the S&P 500 saw support around 1175. That puts the market in line for a better week ahead if the earnings juggernaut provides positive news.

It's also notable that top-performing sectors in 2004 that sold off at the start of 2005, such as homebuilders and steel producers, have recovered. The pullback has been a little more extreme for small-caps, but the rally was stronger for them.

Lagging sectors in the stock market for the week included telecommunications, automakers and transports, while homebuilders, energy producers and basic materials companies gained. Oil resumed its rise, gaining about 6% on the week to finish above $48 a barrel, which helped put a bid under stocks in the energy patch.

Bonds got a scare when the St. Louis Fed president told reporters Thursday night that sooner or later the central bank would remove its commitment to raising rates only at a "pace that is likely to be measured." The yield on the 10-year Treasury note, which moves down when its price rises, finished the week at 4.22%, down from 4.28% a week earlier but up from the intraweek low of 4.17%.

Bush Disappoints

A bunch of dividend-seeking investors got caught leaning the wrong way on Thursday afternoon when the Bush administration issued rules to implement the foreign earnings repatriation tax cut. Under the old law, companies had to pay up to 35% of profits earned abroad when they brought them back into the country. That prompted many manufacturing, pharmaceutical and tech companies to keep hoards of cash stashed overseas away from the tax man but also out of reach for some desirable uses like buying back shares or making acquisitions.

Under the corporate tax cut law that passed in October, companies are now allowed to bring back the money and pay a tax of only 5% this year. To qualify for the tax cut, the money has to be used for certain purposes and no one knew exactly what those would be until the Treasury Department issued rules on Thursday.

Investors had compiled lists of companies with the greatest amount of cash abroad. And Susquehanna Financial Group's Greg Kelly calculated which companies had the most as a percentage of their market capitalization. The top five were










Bausch & Lomb



Eastman Kodak



The Treasury's rules, however, said dividends and stock buybacks were a no-no. Permitted uses included R&D, acquisitions, debt retirement and adding employees. Clearly, some investors had bought the stocks anticipating that the companies would be making moves to increase stock prices like raising their dividends. The late Thursday selloff came as those investors threw in the towel. All five at the top of Kelly's list lost 0.5% to 2% in the last hour or so of Thursday's session.

The ban on stock repurchases was "a significant development" and a surprise given the "purposely nebulous language of the act," Kelly wrote on Friday.

Companies that still could benefit from the tighter rules, according to Kelly, include Kodak, which has said it may do some acquiring,

Eli Lilly



Bristol-Meyers Squibb


, for whom debt repayment is a top priority.

Small Run Over?

Some investors have been buying big pharma for a different reason, expecting the outperformance of small-caps is about to end as a new era of large-cap dominance dawns.

Last year, the S&P 500 gained about 11% while the Russell 2000 rose 18% and the S&P Small-Cap 600 skied 22%. In fact, over the past five years, the S&P posted an average annual return of negative 2% compared with the Russell 2000's average gain of 7%. Large-cap core mutual funds have lost an average of almost 1% a year while small-cap core funds have gained 16% over the past five, according to Morningstar.

With the debate raging, fund manager Chuck Royce -- perhaps the most successful small-cap investor in the industry -- has weighed in for the opposition.

"If anything, the dynamic fourth quarter could set the stage for large-cap to emerge early in 2005 as a market leader," Royce said in a 2005 outlook on his Web site. "I think that it was a very telling sign that large-caps outperformed small-caps in the low- to negative-return period between April and September. Where investors turn in tough times tends to be very revealing."

Royce's $3.2 billion


Premier Fund, which has gained almost 15% a year for the past 10 years, was only 85% invested in stocks at the end of 2004. The biggest holdings were in

Florida Rock Industries



Nu Skin Enterprises



Ensign Resource Service Group

, which trades in Toronto,

Endo Pharmaceuticals



Simpson Manufacturing



So far in 2005, small-caps are trailing, as the Russell 2000 has lost almost 6%. There's only one reason to doubt Royce's prognostication for 2005: He made the same call a year earlier and then, happily, was proved wrong.

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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