The Dow ended the week totally directionless and only +18 points from where it started on Monday. Other than the brief jump over 11100 on Monday the Dow traded in a very narrow range between 11000-11100 all week. The Dow is consolidating from the +650 point gains over the last several weeks. The Nasdaq had a pretty good week gaining over +140 points and edging ever closer to 4000. The intraday high on Friday was 3980 and after trading over its 200DMA it slipped -20 points back below the 3949 barrier.
Higher oil prices hit the transports again this week and the index has now bounced off upper resistance at 2930 four times since March. With inventories at low levels and expectations of even higher heating oil prices for winter, Dow theory followers are looking at a drag on future Dow rallies. The challenge now is the low inventories. Nobody wants to buy oil for today's high prices and then be forced to sell it cheaper later if OPEC raises output. The lack of buying could turn into a race to fill winter requirements once OPEC direction is clear. If they are not going to raise output then some analysts project oil could run as high as $50 a barrel by winter. The prospect of even higher oil prices has put a cloud of uncertainty over the market. Somewhat higher oil actually helps the Fed by putting price pressures on the market. This requires fewer interest rate hikes from the Fed. However, over $35 the Fed would start squirming as those prices started filtering through the economy and become critical.
Oil prices did not put any pressure on the semiconductor sector this week as Merrill Lynch joined the crowd upgrading the sector. Merrill said on Friday the mid-cycle correction on the chip sector was over and recommended that investors buy chips more aggressively going forward. Late to the party but a good call. With the sector up strongly for the last six days we cold see some profit taking any day.
The bluest of the blue chips were in the news on Friday. AT&T was rumored to be in merger talks with British Telecom. With T trading near a three year low at $31 it is not surprising considering the consolidation taking place in the telecom sector. The companies acknowledged that talks had taken place but there was no current deal. Also grabbing a share of the spotlight on Friday was GM after Carl Ichan said he was going to buy up to 15% of the outstanding GM stock. Now that is a trading account to covet!! The reason for the move according to analysts was to force GM to complete the spin off of the remaining portion of GM Hughes (GMH) that it still owns. Analysts theorize that a quick spin off could produce a 22% profit for Ichan. We should teach him about option leverage if he thinks 22% is a good deal! Of course with options he would not have the leverage against the company that actually owning the stock would produce. Also, I would not doubt that he probably will end up with quite a few long calls as well before the deal is over.
The bluest chip on the Internet lost some of its shine on Friday with a -$6 drop. Yahoo experienced a wave of selling as the Thursday rating filtered into portfolios. Decreased advertising rates and volume is impacting Internet companies across the sector but as the most visible sector leader Yahoo may lead the decline. As YHOO goes, so goes the sector. This is just another round of deflation as business plans meet reality. We have seen what happened to the E-commerce sector with stocks like ETYS, EFTD, FLWS, BNBN, VSHP and PLRX after they failed to follow through with profits as expected. The Internet stock slide will continue to be a drag on the Nasdaq as investors who bought the expectation and rumors are now faced with selling the news.
The slowing economy is slowing? Yes, that is the newest wave of analysis by economists. The slowing is slowing and actually may be reversing into growth mode again. Where most analysts expect no movement on interest rates next Tuesday, some were even expecting the next move to be a rate cut. Now there is a growing rumor that there could actually be more rate hikes after the election. OOPS! Where did that come from? Earnings have been stellar and productivity is still soaring. Employment is still very tight and retail sales are still increasing. Actually the impact of the rate hikes is almost invisible. Previously a string of rate hikes like we have had in the last year could have put a serious dent not only in the economy but also in the markets. Don't look now but the Dow is only about -650 points from its all time high and looking like it is poised to breakout. The Nasdaq is still trading at more than -25% off its highs but most of those highs were Internet related and we all know what is happening there. The rate hikes just have not had the intended impact. The slowing "slowing" is going to bite us eventually.
With the Dow only a couple hundred points from an eight month high and the VIX at a 52-week low (19.42) I went back and revisited the Aug-Sept-Oct period from the last two years. Was there really a Labor Day rally? Did a rate hike or no hike at the August FOMC meeting have any impact? What can we really expect next week? Will we have a rally or a "sell on the news" event? What I found was not pretty.
In 1999 the Fed met on August 24th and raised interest rates. The Dow hit an all time high of 11365 on that same Tuesday. Go figure? However, two days later the Dow began a better than -10% drop to a low of 9976 on October-18th. Still in the middle of this drop there was a +410 rally from the Sept-2nd intraday low to the Sept-9th intraday high. The Dow lost -1100 points in the next four weeks. The Nasdaq dropped slightly after the Fed rate hike but basically traded flat to up until Sept-23rd when the crashing Dow finally took its toll. Even in this rate hike environment both indexes managed to rally for the week after Labor Day.
in 1998 the Fed met on August 18th and did not raise rates. On that day the Dow hit 8753 which was a three week high and almost the high for the month. By September first the Dow had fallen to an eight month low of 7401 or a -1300 point drop. This happened without a rate hike. Beginning on Sept-4th the Dow rallied +781 points by Sept-24th to 8182 only to fall off into the October abyss the following week. The Nasdaq dropped after the Aug-18th meeting from 1874 to a Sept-1st low of 1475 or -400 points. From Sept-1st to Sept-23rd the Nasdaq rallied regaining +300 of those points before hitting the October crash. There was no rate hike but the market crashed after the meeting in August but rallied after Labor Day.
At both meetings the Dow was at or near its highs. In 1999 the VIX spiked the day after the meeting to a low of 20.31 as bullish sentiment reigned supreme even in the face of the rate hike. A better than -10% drop began the next day. In 1998 the markets were undergoing extreme volatility and the VIX on the meeting day hit a low of only 26.39 but then soared as the market dropped -1300 points to a high of almost 61, yes, sixty-one! That was and still is the all time high for the VIX on Oct-4th 1998. The previous high was 53.06 on Sept-1st 1998, twelve days after the no-hike Fed meeting and at the market low for the year of 7401.
Now that I have bored you with all the important market stats I think the case is clear for a post Labor Day rally. HOWEVER, I also think you could create a very good case for a serious dip between the meeting and Labor Day. The similarities are simply too clear and too precise. The only things in our favor are the recent market sell off earlier this year and the general feeling that the next Fed move may be a cut and not a hike. Now think back to the earlier paragraph where I discussed the murmuring of another hike in our future. Maybe a Fed on hold is not such a sure thing. In 1998 the markets had rallied all spring and summer were very over bought. In 1999 the markets had rallied in the spring and then traded sideways through the summer. This year we hit our high in January and traded sideways or down in a decreasing range ever since.
The big question remains the Fed. If the Fed says something in their release on Tuesday that can be taken as indications of a future hike then the remaining August outlook may be grim. The last two weeks of August don't have history on their side regardless of the Fed direction. Factor in worry about $50 oil and that becomes the joker in our stacked deck. If the soft landing the Fed wants becomes a fly by instead then Greenspan will act aggressively in the future. Alan will get a chance to speak to the markets this week at the Kansas City Fed meeting on Thursday and should he desire to use words instead of rates to hold back the markets this would be the day. With the markets nearing recent highs on the rallies from the last several weeks there is a good chance that the expected "no hike" is already priced in. If that is the case then we are setup for a classic "buy the rumor, sell the news" event. Still, if the Fed does the expected and Greenspan stays mum then the "why wait for Labor Day" sentiment may prevail. At this point, I am not betting on that outcome. The extreme net short positions of institutional S&P traders along with the 52-week low for the VIX is weighing on my subconscious. I hope it weighs on yours as well. I am not saying don't trade since a short covering rally for those institutions would be huge but just keep your eyes open to intraday market conditions and your finger on the trigger. Consider the next two weeks an episode of the Twilight Zone where the least unexpected event is the most likely occurrence.
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