Nets Trade Higher Despite Downgrades

Internet stocks posted 2% gains Monday despite downgrades to 11 stocks by Merrill Lynch analyst Henry Blodget.

The ISDEX gained 14 to 745, and the Nasdaq rose 65 to 3853. The S&P 500 climbed 13 to 1476, and the Dow added 77 to 10,845. Volume declined to 385 million shares on the NYSE and 594 million on the Nasdaq. Advancers led 15 to 10 on the NYSE and 20 to 14 on the Nasdaq. The big economic reports for the week are tomorrow’s second-quarter productivity and Friday’s Producer Price Index. Cisco reports earnings tomorrow, Applied Materials on Wednesday and Dell Computer on Thursday. For earnings reports, visit our earnings calendar and reported earnings.

Blodget claimed his rating changes weren’t so much downgrades as a “resetting” of ratings on Internet stocks, adding the Neutral rating in addition to Accumulate and Buy. The point was to encourage greater selectivity among investors in the group.

barnesandnoble.com was one of the ones to wake up Monday with a Neutral rating, down from Accumulate, but the stock gained 1 1/4 to 5 on news of an e-books alliance with Microsoft . eToys also was dropped from Accumulate to Neutral, and the stock slipped 1/16 to 4 3/16.

Dropped from Buy to Accumulate were Webvan , off 7/32 to 4 25/32, Pets.com , up 7/32 to 1 1/2, Quokka Sports , down 15/16 to 6 1/16, iVillage , off 1/16 to 4 3/16, eBay , down 1/4 to 50 1/2, DoubleClick , up 1 5/16 to 36 1/2, Buy.com , down 17/32 to 3 1/8, and 24/7 Media , off 1 3/8 to 10 1/16.

i2 Technologies led the ISDEX higher, adding 12 9/16 to 138 5/8 after the B2B joint venture MyAircraft.com was cleared by European regulators. i2 was also part of a joint venture to streamline the B2B transaction payment process with Enron , Wells Fargo and S1 . S1 added 1/16 to 17 1/4 after trading as high as 19.

Adam.com gained 13/32 to 5 1/32 after reporting a second-quarter loss of 28 cents, vs. a 51-cent loss in the year-ago quarter.

Adatom.com gained 1/4 to 1 7/16 on news of a deal with the China Product Trade Net Center.

EarthLink gained 3/4 to 11 11/16 on news that it had expanded business-grade DSL service from 4 to 14 cities.

Storage Networks gained 14 to 136 on news of a deal with Lycos . Sonus Networks continue to gain on last week’s bullish conference presentation, adding 19 1/16 to 237 1/16.

Some technical comments on the market: Nice day in the markets, but the lower volume means we are still waiting for the high-volume follow-through to last Thursday’s reversal. The indexes are at some interesting resistance points: the Dow is just under 10,875, where it turned back recently; the S&P 500 is right at the bottom of 1480-1488 resistance; and the Nasdaq is just below its 200-day moving average (3906). The S&P 500 may still be forming a bearish flag here, and the break of rising wedges recently on the S&P, Nasdaq and the ISDEX gives us potential for a lot of downside if this rally fails. The Nasdaq’s break of its bearish rising wedge gives it potential downside to 3042. A break and close below 3500 would be a big warning sign. Interestingly, the selling ended last week right at the 62% retracement level (3521) of the move from 3042 to 4289. The decline was also halted by the Nasdaq’s October 1998 trendline. The ISDEX needs to get above 770 quickly to negate its breakdown out of a bearish rising wedge. That broken wedge gives the

ISDEX potential downside to 560. Above 770 is 790 resistance, and above that, the ISDEX turned back recently at 840, just below its 50% retracement level of 845. Support levels on the ISDEX are 693-700, 650 and 600. The S&P’s broken rising wedge gives it potential downside to 1361. Critical support is 1390, the index’s October 1998 uptrend line. A break of that trendline could carry the S&P to 1170 or lower, so we do not want to violate that line. The Dow is only about 100 points from the upper boundary (just under 11,000) of its bearish diamond pattern. The lower boundary is about 10,450, but we’ll continue to use 10,200-10,300 because of strong support in that range and the requirement of a 3% break of a major pattern. A break of that line could carry the Dow as low as 8,500. Recent support on the Dow is 10,675. Recession indicator: short-term treasury bond yields rose above 10-year bond yields last week and have stayed there since. Over the last 40 years, this phenomenon occurring for two consecutive months has presaged a recession within six months 86% of the time. Short-term yields are now threatening to rise above 5-year yields; if they do, the yield curve inversion will be complete. There are positive factors behind the inversion, such as the government’s buyback of long-term bonds due to the federal budget surplus, but it is nonetheless worth keeping an eye on.

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