Cisco Drags Stocks Lower

Stocks struggled to stay in positive territory on Thursday despite disappointing results from Cisco Systems, but finally succumbed to selling pressure in the final hour of trading.

The ISDEX fell 3 to 151, and the Nasdaq lost 30 to 1782. The S&P 500 declined 3 to 1080, and the Dow fell 27 to 9625. Volume declined to 1.43 billion shares on the NYSE, and 1.99 billion on the Nasdaq. Decliners led by 19 to 11 on the NYSE, and 23 to 12 on the Nasdaq.

After the close, TriQuint , EDS and GlobeSpan Virata topped estimates.

During the day, Cisco gapped below its 200-day moving average and fell 8% after beating estimates handily – but then only giving guidance for one quarter because visibility remains limited. The company’s results were also helped by deferred revenues, and Dresdner Kleinwort Wasserstein downgraded the stock to Sell based on accounting concerns. The stock’s chart says it all; see Market Commentary below.

Symantec and Genesis Microchip fell on negative analyst comments.

Overture recovered a big chunk of yesterday’s huge decline after the company raised guidance and said the loss of EarthLink’s business will not have a material effect on results.

Some technical comments on the market: Note: To see the charts in the text email newsletter, click on the story link at the top of the newsletter.

There was a reason we repeatedly criticized the practice of pro forma accounting last year, and hopefully those reasons are clear to all by now. The market is in such a downward spiral due to a crisis of confidence caused by accounting implosions that we are not sure when it will end or what it will take to restore confidence. Stocks may just need to fall until investors find them compelling values again. And it’s not just about Enron. The implosion of Elan , which to all appearances seemed like a solid drug company, is another blow to investor confidence. Of the companies we were cautious on last year because of their reliance on pro forma accounting and writedowns, a few stick out in our mind: Homestore , which is now a penny stock; VeriSign , which has lost half its value since late October; and Cisco , which gapped below its 200-day moving average today and kept going (see first chart below). Cisco may be one of the best free cash flow generators in the market, but its insistence on using pro forma accounting last year is hurting it now. One last comment and then we’ll get on with our regularly scheduled programming. One thing that most investors and analysts seem unable to grasp is the very basis of what makes a good investment: fundamentals that are both attractive and improving. There are only two places in the market that we’ve seen both of those criteria come together in recent months: gold stocks, which have gained 50%-100% since late November, and select homeland defense stocks like InVision and OSI Systems . Both those sectors are a little extended right now and face a lot of uncertainty, and thus may not be the best place to put new money to work right now, but to call them overvalued shows a failure to grasp the fundamentals. Harmony Gold Mining may have a PE north of 50 right now, but it will likely earn more than $1 a share this year, giving it a forward PE of 9 or lower. And InVision may look pricey with a $500 million market cap – until you consider that airports may be spending $1-$2 billion on bomb detection equipment over the next year or so. Again, not an endorsement of these stocks at these levels – we recommended them at much lower levels than this – but the ability to recognize fundamental change early on is where the greatest investment opportunities lie. The S&P 500 at a GAAP PE of 42 does not meet the valuation criteria even if earnings rebound smartly this year.

And now on to the market. Stocks have been unable to put any manner of rally together, and we suspect at this point that it may not happen until the S&P hits the 1052 level (see second chart below). The index has been supported by a declining trendline that should be just under 1075 tomorrow; if that trendline breaks, a waterfall down could be the result. Rallies have been stopped at 1094 the last two days. The Nasdaq (third chart) fell below a declining trendline yesterday and is sitting right above a very critical support zone from 1740-1780. Resistance is at 1820 for tomorrow. Note in the Nasdaq chart that the trend strength indicator ADX has now turned up, following the S&P into a strong downtrend. The Dow (fourth chart) appears to be forming a diamond consolidation here, which is usually bearish. 9500-9600 is support, and 9740-9760 is resistance.

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