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The Dow led by a suddenly reborn group of cyclical stocks ended the day up just 16.65, while weakness in the oils, drugs, brokerage, and tech sector led to a sharp selloff in NASDAQ and the S&P.  Despite a 76.04 point selloff in NASDAQ and a drop of 21.32 in the S&P 500, breadth was decidedly positive with advancers leading decliners by 431 issues on the NYSE and by 318 issues on NASDAQ.

While the sudden emergence of the cyclical stocks and the day's positive breadth numbers at first glance point to a broadening of the rally, we wouldn't be so quick to jump the gun.  Rather than a broadening of the rally, the move to the cyclicals will more likely prove to be a case of sector rotation, with the former leaders (the oils, drugs, tech stocks, and speculative Internet issues) entering a declining phase while the cyclicals rally.  Rather than a broad based advance, the market will likely continue to be led by a narrow group of stocks.

Likewise, we wouldn't get too excited by the recent strength in the Russell 2000, for here too looks can be deceiving.  While the Russell is often regarded as a barometer of the small cap sector, a quick glance at the top companies by market cap in the index shows such large cap names as CMGI, E-Trade, and Real Networks among others.  The top 5 companies in the index exert the same influence on the index as the top 5 companies in the NASDAQ 100 do on the NASDAQ's day to day moves.   A large part of the Russell's recent move is directly attributable to its top 5 stocks which have been on a tear of late.  Strip out these 5 stocks, and the picture painted by the Russell does not indicate the beginning of a small cap rally.

The one constant in this market, as leadership shifts from group to group, has been buying that is based on hope rather than actual results.  We have seen it in the Internet sector ad nauseum, where investors buy stocks based solely on a dream that one day a $4 million in revenues company will grow into its $1 billion market cap.  We are likely seeing it now in the cyclicals, where investors are buying on the hopes of global economic recovery, rather than actual signs that a recovery is at hand.

While a recovery from economic depression is beginning to take place in Southeast Asia and South Korea, the recovery in the market upon which investors are pinning much of their hopes, Japan, remains little more than a dream at this point as economic report after economic report continue to point to an economy balancing on the brink of disaster rather than to an economy in recovery mode. 

Investors in the cyclical stocks will likely face disappointment in the coming months as their hopes for recovery are dashed by continuing weakness in Japan, and a further worsening of the situation in German where recent interest rate cuts will not solve the country's structural problems.

The market continues to be a study in contrasts, a balancing of the positive and the negative, a market of the few and a market of the many.  As we said a few weeks ago, investors continue to see a glass half full, rather than one that is half empty when they view the market.  The key to a continued rise in the major averages remains an investor who is able to see the positive side of the facts, while disregarding the negative.

We expect the current myopic vision of the retail investor to undergo a shift this quarter, but it will be a gradual shift, as a slow steady chipping away of built up beliefs occurs throughout the quarter.  The ability of investors to disregard the bad news while only focusing on the good is a sign of a firmly entrenched trend that is likely to continue. When the bad news starts to be contemplated rather than discarded, that is when the first warning bell rings that the present trend is in trouble, and a change in direction is imminent.

After the bell news from Intel and Infoseek illustrates the current dichotomy in sentiment that is taking place in the market as bullish sentiment continues to be focused in an increasingly narrow strata of issues, while negative sentiment increases in the sectors that have been left by the wayside.  A steady stream of earnings warnings in the tech sector over the past few months has slowly chipped away at investors' resolve to stay the course--where once only the sunny side of any announcement (the glass half full) was seen, now the balance has tilted and the good as well as the bad is contemplated when making an investment decision.  In a healthy trend investors' would have focused on the positive side of Intel's earnings report: the beating of estimates by 2 cents, while downplaying the negative: the revenue shortfall.   In a trend that has run its course the focus shifts to the opposite side of the street: the revenue outlook, and the glass is no longer seen as half full, it is now seen as half empty.

Infoseek by contrast operates in a sector where sentiment has yet to be damaged, and where only the positive news is filtered into decisions, as is normal during a strongly trending market. In after hours trading following its earnings release Infoseek rose 3/4 of a point as investors focused on the positive: the reporting of a narrower than expected loss.  By contrast, in a trend that is wavering, the attention of investors would have been on the negative side of Infoseek's announcement (the glass half empty): a 2% decrease in revenues, and a loss of 39 cents a share compared to 6 cents in the prior year.

The perception of events, and the ability to filter out the trend opposing news while focusing only on the news that is sympathetic to the current market direction, is the key to the continuation of any trend.  We have seen the balance shift in the (hardware) tech sector in recent weeks, and we are likely to see additional sectors join the ranks of the out of favor in the coming weeks as the focus shifts to second quarter earnings.

A surging Internet sector, bargain hunters (Warren Buffett was noticeably absent for some reason, as were Graham and Dodd), and a strong Financial sector helped the market reverse course and power ahead to new record highs. The Dow closed above the 10322 resistance level at 10339.51. 

The Dow's ability to hold the 10322 level will likely be tested in today's trading.  The market is unlikely to make much headway today as short term sentiment does a balancing act between expected strong earnings reports from a trio of brokerage firms on the one hand and a renewed case of earnings fears ahead of Intel's numbers on the other hand. The key to Intel's report will be the conference call, the actual numbers reported today have already been discounted.  Unless the company drops a bombshell about June quarter earnings, we look for the tech sector to rally tomorrow and pull the rest of the market up with it for the remainder of the week. 

The key resistance levels to watch are 10322 and 10472 on the Dow, and 1373 on the S&P.  After this week the major averages will likely find the going much more difficult.  The flow of 401K and IRA funds into the market ends on Friday, and with the end of the seasonal inflow ends the market's margin of error cushion.

Now we must admit that perhaps we are set in our ways, and perhaps that accounts for our inability to understand the new math of the new paradigm, but around here Friday's IPO market action had all the trappings of an end of trend retail-led speculative binge.  In recent weeks we have seen $7 billion in revenues Pepsi Bottling Group being valued at $3.3 billion after its debut, while $44 million in revenues priceline.com Inc. garnered a $10.5 billion market cap.  Perhaps market history has been made irrelevant with the dawn of the Goldilockian Era, but in the past when retail investors started acting as if the stock market was an Atlantic City slot machine it spelled trouble for the market.

We don't for a minute entertain the idea around here that Friday's binge marked the apex of the public's speculative fever, that will likely come next month when the Goldman Sachs IPO will likely ring the bell for a change in market trend.  Friday's action was just a little warning siren that the time to make profits on the upside by indiscriminately throwing coins in the fountain is nearing an end.

The time to make profits on the upside ended for Compaq Computer investors with the closing bell on Friday.  The PC maker's after the close earnings warning stunned a few analysts, but came as no surprise to those of us who have opined on the increasingly commodity like nature of the PC business.  Face it, commodity producers should not trade at a premium to the market. 

The PC maker's earnings warning (or should we say, earnings halving) has  awakened the earnings jitters crowd from their week long sleep.  S&P Futures are down 20 points in early trading, and the tech stock (ex Internet) will be under heavy pressure when trading begins this morning.