Are we suspicious of the rally?
You bet. But enjoy it while you can. We may see it for a few more days until the euphoria wears off. In the meantime, thank goodness for favorable PPI numbers. While bearish tones gripped the market with force early last week, the bulls just couldn't take it any more and put the PPI up as the Holy Grail for the rally that ensued. In truth, the key to the whole battle was that bears moved to the sidelines to wait it out, while bulls were looking for any excuse to run the market up. However, based on still sub-1 bln. share volume in both the NASDAQ and DOW, We think the markets movement is based on lack of selling, not a new bullish trend.
Let's take a closer look. In short, Friday's action was borne of a flat Producers Price Index (PPI). By its name, you can infer that it's a reflection of prices at the wholesale and producer level. The Consumer Price Index (CPI) by contrast is a reflection of retail price levels, or the prices that we all pay for goods and services in our daily lives. It's the same comparison between a bushel of corn in a field of many, and an ear of corn from the produce section of your favorite grocery store. The big difference in the readings is that the CPI is about 58% weighted in services, which are nowhere to be found in the PPI. So there's still a bit of a wild card in the CPI, thanks to its inclusion of services. We'll have to wait until Tuesday morning's release of those figures before we can offer any comment.
Anyway, the PPI reflected a flat 0.0% increase at its core rate. Yes, energy (a.k.a. oil) was up a whopping 3%, which in our book is a big red flag of future inflation. After all, as we've said before, oil is the economic engine of the western world - without it, we'd be living in caves still trying to catch dinner with a pointy stick. In what to us is a major surprise, OPEC is closely adhering to its prescribed limits, moving the price of oil up. We need it no matter what it costs. But the market is willing to overlook that for now. The truly good news was that on every other level, from food to cars to computers, prices actually fell. The overall PPI figure was +0.2% compared to the market's expectation of +0.3%, which anybody would have to view favorably. And so they did. The bond market led the way by shedding about 16 basis points throughout the day on Friday to close at 6.10%. If you can believe it, there was actually talk the Fed may not raise rates at the August 24 FOMC meeting. Yeah right. . .fat chance. While we would agree on principal that a rate hike isn't necessary and shouldn't be implemented, based on the lack of inflationary signs (except oil, which we've already touched on), it's still all but sure to happen anyway. Even so, the positive PPI numbers remove another inflation indicator from the Fed's "keep-your-eye-on-it-list" and also ease the fear of a disturbing CPI figure on Tuesday.
The DOW gapped up about 100 points on Friday's open to 10,900, its Thursday high (before the power went out). From there, a steady ascent to 10,981 ensued before backing off slightly to finish the day at 10,973, up 185 points. The A/D line looked great as advancers skunked decliners all day. In the end, 1952 advancers cleaned the clock on 1037 decliners, with volume of only 692 mln. shares. This is actually pretty low. But for a Friday in August, it moves up a notch on the importance scale, but still nothing to write home about. Unfortunately, there were just 42 new highs compared to 158 new lows. Aside from unconvincing volume, if there was a weak spot in the internals, this was it. These are not the signs of a sustainable rally. If you need proof, just take a look at IBM. At one point today, it was reported that it took 20 minutes to move just 50,000 shares - no inspiration here.
For the technical chartists in the group, on one hand, the DOW is at its 50-dma and could bounce south, while on the other hand, it's already bounced north off its 100-dma. You choose. We think in the grand scheme of things though, sentiment will mow down any chart average on the planet. In this case, it's better to pay attention to the trading environment than a line on the chart.
The NASDAQ, home of most technology stocks, and consequently the more rate sensitive index had a big day too, reflecting the substantial bond yield drop. The index gapped and climbed to close at 2635, up 88 points, which looks good when viewed through 1-week goggles. However, the weeks of April 19, May 10 and June 21 show this level as a peak from which the market went down. The gains in July were earnings driven. Not trying to scare you - just pointing it out. See what we mean on the graph.
We are still cautious here. Nonetheless, today's rally, based on relevant PPI data looked OK. Like the DOW, advancers tap-danced all over decliners 2432 to 1467. The good news is that new highs actually outpaced new lows 86 to 58. We haven't seen that in a while (take a bow). Volume was respectable for a Friday in August at 937 mln. shares, but far less convincing than the 1 bln. shares we'd like to see for a strong move up.
Honestly folks, no matter what you think of volume, it's the only thing that's going raise the price of a stock. Without volume, advances are subject to pullbacks and we remain in trading ranges. Breakouts mean very little without volume.
Let's put a little more highlight on the volume issue. A few sectors put on great performances today. Retail, technology (including Internets), financials and Drugs. Take the drug issues, in particular Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY). Their respective average daily volumes are 4.93 mln., 7.08 mln., and 2.87 mln. Today's volumes exceeded these averages by strong margins: 7.08 mln. (numerical coincidence), 10.25 mln. and 3.35 mln., respectively. When this happens, especially on a Summer Friday, you can be pretty sure, it's not from folks pulling off the road in their motor homes to call Schwab with an order. This kind of volume is the trail that funds and money mangers leave behind. It's not just the high tide floating all boats.
Now contrast this with the Internet sector's AOL, AMZN, YHOO and CMGI. Respective average daily volumes here are 22.12 mln., 8.49 mln., 9.25 mln., and 6.22 mln. However, note their volumes today of just 14.53 mln., 5.39 mln., 6.12 mln., and 4.79 mln. Is this indicative to you that a big rally is at hand? Not even close. This is clearly a case of the tide floating the boat (interest rate driven, not buying pressure driven). Don't get us wrong; we're all for big price moves that Internets give us. The point we are trying to convey is that Internets are not as likely to sustain their rally compared to other sectors, as conveyed by an absence of volume relative to their daily averages. Beware the head-fake.
In condensed version, here's other news of interest. Red Hat Software (RHAT) continues to rocket ahead from its $14 IPO on Wednesday only to close at $85 on Friday. Iridium (IRID), the satellite-based telephone system was forced into chapter 11 bankruptcy by its creditors. Intel set another new high of $79.75 - about a 60% move in 2.5 months (profit taking anyone?). Finally, a competing bid to Alcoa's bid for Reynolds metals surfaced today from Michigan Avenue Partners, a scrappy and much smaller rival of Alcoa.
All clutter, theory, and hyperbole aside, we were due for a small reprieve and this is pretty good. The PPI has removed an element of fear, while investors await the CPI on Tuesday morning. Aside from the price of oil, which the market appears willing to overlook, the CPI will most likely give investors another reason to cheer, though something could fly out of left field to spook the markets back down. But we don't think so. Monday should be an up day, but may see a pullback late in the afternoon prior to the CPI release. Assuming no surprises from the CPI, sentiment is likely strong enough to carry the market further up. In short, we could get 2 days of price gains on Monday and Tuesday.
However, we want to stress that you use caution. One CPI hiccup, and we'll head right back where we came from. We will anyway; it will just be delayed a couple of days. The fact is the Fed will still most likely act to raise rates, despite benign PPI and CPI. That hasn't changed. What also hasn't changed is that earnings season isn't until late September, and it's usually a weak quarter. To boot, we've still got that pesky oil price moving insidiously up, and 138 days remaining until Y2K. There just aren't any events on the horizon to cause much enthusiasm. Remember, the market is a great humiliator and strives to embarrass as many people as possible. Don't get caught in the euphoria. It shouldn't last long, and when it's over (probably soon), the trend will be down. Form a plan and stick to it, using stops if the trade moves against you. Of course, sell too soon.