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Monday Blues
By James Brown

http://www.asianinvestoronline.com/marketwrap/060903_1.asp

The market pull back in Monday's session was no surprise after Friday's high-volume reversal day. For days market analysts have been parroting the same line (in stereo), "Yes, we're bullish on the markets but cautious on the short-term. The markets have come too far, too fast." The bulls' run on Wall Street appears temporarily exhausted as they pause to catch their breath. Or has it? How deep (or shallow) would be pull back have been had it not been for the downpour of bad news today? The DJIA fell some 82 points to close under the 9000 level as shares of Boeing (BA) and Walt Disney (DIS) led 27 of the 30 components into the red. Seeing green were shares of IBM, which bounced 2.4 percent off support at the $80 level. The NASDAQ composite lost 23 points to close at 1603. The S&P 500 index dropped nearly 12 points to just under 976. Out of the twenty sector-specific indices I watch only one closed in the green and that was the OSX oil services index, which gained 40 cents to close at 96.60.

Chart of the Dow Jones Industrials:


Chart of the NASDAQ Composite:


Chart of the S&P 500 Index:


As you could expect market internals were negative with declining issues rushing past advancing issues by 20 to 8 on the NYSE and 2 to 1 on the NASDAQ. New highs took a big step back coming in at 266 to just 15 new lows. Volume was still decent with 1.6 billion on the NYSE and 1.8 billion on the NASDAQ but down volume swamped up volume almost 5-to-1 on the Big Board and more than 3- to-1 on the NASDAQ. Volatility indices, which had been rebounding from their late May lows, continued to climb higher.

Freddie's Financial Faux Pas

Freddie Mac (NYSE:FRE), the U.S. government-backed home loan lender, lost more than 16 percent to close at $50.26 after announcing the company's plan to clean house with its upper management team. FRE said that its chairman and chief executive officer was retiring, that its CFO was resigning and that its COO was being terminated. The culprit, once again, was revenue recognition (the same issue IBM is being probed for). It appears that FRE's COO is alleged to have been less than honest with the company's audit committee and that he was material in managing the company's numbers in a practice called "smoothing". In this case, FRE under reported past profits to be accounted for later during slow quarters, hence the smoothing out of its relative performance quarter over quarter. While any restatements of FRE's earnings between 2000 and 2002 would likely raise previous results FRE felt that these "profits" would be counterbalanced by slower results in the future.

OptionInvestor suggested buying puts or going short Freddie Mac two weeks ago when the stock broke down through its rising channel on news that it was losing market share to its rival Fannie Mae (FNM). Unfortunately, the broader market's strength was too infectious and lifted FRE back above resistance at its 200-dma and the $60.00 level and we were stopped out. FRE is such a major player in the mortgage market (between FRE and FNM they control more than 40% of the U.S. mortgage market) that one could have assumed that such a shake up would have done even more damage to the stock and investor confidence. It's probable that because any earnings revisions are expected to be higher that the sell-off was less severe than it could have been. Still, the news helped drive investors to the safety of bonds and accelerated some of the profit taking already under way in the overbought home building sector.