So Long, September
Good Riddance. For the month of September, the Dow lost an impressive 1,072 points. Looking at the third quarter as a whole, the blue chips finished lower by 1,652 points. Coincidence or not, the 3rd quarter of 2001 represented a loss of 1655 points. On a percentage basis, the Dow lost 17.8% in the 3rd quarter, and, according to the Stock Trader's Almanac, only the 30.7 percent drop during 1931 was worse. For the year, the Dow is down 2,430 points, or 24%. Looking at other markets, the Nasdaq lost roughly 11 percent for September and 20 percent for the quarter, its fourth-worst third-quarter performance ever. The S&P suffered its worst third-quarter results since 1987, dropping about 17 percent for the quarter and 11 percent for the month.
Looking at September 30th specifically, this last trading day of the month and quarter certainly started out on a powerful down note. The blue chips opened down over 100 points during the first few minutes of trading, soon after testing the July 24th low of 7532 and buyers' patience. Speaking of technical levels, the late-day rebound did have the Dow test the July 23rd low of 7682 (7685 high rebound level) before falling into the close. At session's close, the Dow had fallen by 109 points, or 1.42%, to 7591.
The catalysts were numerous. Traders first focused on foreign markets showing sizable losses overnight; France lower by 5.3%, Germany off 4.7%, and the UK down 3.75% before the U.S. markets had a chance to open. Bonds were up significantly, and stock futures all were showing deep shades of red. Other negative developments included GE cutting estimates, WMT lowering sales guidance, an EBAY downgrade, coupled with weak economic reports. Sectors coming under pressure on Monday included Retail, software, semiconductor, and networking issues. Indices that outperformed were gold, biotech, tobacco, and utility shares.
Beginning with General Electric (GE), Merrill Lynch cut estimates early on Monday to reflect concerns over a deteriorating economy and GE's short cycle business plan. The earnings cuts by Merrill followed similar statements from Lehman and CSFB during Friday's session. Shares of GE closed higher by 0.18 cents at 24.65, rebounding from a low of 23.51 and attempt to test 23.02 low set on July 24th. Under 23.02, and a chartist would have to look back to October 1998 to find support.
Wal-Mart, on the other hand, lowered sales guidance and took the entire retail sector down with it. The company reportedly lowered September same-store sales towards the low-end of the rand (3-6%), and also stated that FY 2002 earnings will come in at 1.76-1.78 versus consensus estimates of 1.79. Shares of WMT fell 3.90% to 49.24, while the S&P Retail Index lost 11.51 points, or 4.16%, to close at 264.54.
Taking down technology issues was helped by shares of eBay (EBAY), losing 8.15% to 52.81 after being downgraded by RBC Capital Markets to "under perform" from "sector perform" and having its price target cut to $45 from $70. Other technology shares losing ground included shares of Intel (INTC), falling by 5% to 13.89 after the company's CEO said he doesn't expect a real turnaround in computer sales until companies return to profitability and start spending money on technology. Rounding out the technology behemoths, MSFT, CSCO, and IBM all went lower on Monday as the Nasdaq and QQQ's lost 2.25 and 2.76%, respectively.
If foreign and domestic equity weakness was not enough, investors had to deal with weaker-than-expected economic releases. Starting with Personal Income and Spending reports, both fell short of the 0.5% expectations economists had hoped for. Personal Income rose 0.4%, while Personal Spending increased a mere 0.3%. The retail sales and august employment report portended strong consumption figures; however, spending on the service level was tame while growth within the auto sector remained volatile. This shortfall should have economists looking for slightly less growth out of the 3Q GDP.
The main economic release on Monday came at 10:00 a.m. Bonds were already significantly higher, the Dow was near its intra-day low (hindsight of course), and the release of the Chicago Purchasing Manager's Index (PMI) evidently lead to some temporary capitulation. Expectations were for a slight decrease to 53 from 54.9, month prior. Therefore, the 6.8-point drop to 48.1 and first sub-50 reading since January was clearly unexpected. Regional volatility in new orders was the likely culprit, falling 6.6 points to 49.2. In May, new orders came in at 65.6. Note: September ISM Index will be released at 10:00 a.m. on Tuesday, with expectations for a slight up tick in growth to 51 from 50.5.
Gathering attention before, during, and after the Chicago's PMI Index was activity in the bond market, especially the two-year note. The cash 2-year note closed at 1.69%, below the Fed Funds rate of 1.75%. This is called a "negative carry," since it will cost institutions 1.75% to borrow money that they need to hold inventory of 2-year notes. Historically, the 2-year note has fallen under the Federal Funds rate only four times in the last 13 years. Following such an occurrence, the Fed usually lowers the funds rate within the next few months. Note: The next meeting is November 6.
Another barometer for Fed action is the implied yield on the federal funds futures contract, currently indicating that there is almost a 100-percent chance the Fed will cut rates by 0.25 percentage points before its next policy meeting. The December Fed Funds futures contract is currently at 98.57, or 1.43% (32 basis points under the Federal Funds rate).
Keeping with bond futures theme, it was interesting that the December Bond closed only three ticks above its opening level of 114-05. The high in the contract was 114-31 (double-top with last Wednesday), while the recorded low was 114-07. At 3 p.m. eastern time, the 30-year closed at 114-08. This could give some fixed-income participants reason to take profits and enter equities.
The yield curve, on the other hand, closed very strong, with the five-year note up 20.5 ticks and 10-year bond higher by 20. This is a 43 tick steepener and significantly bearish for stocks.
Looking into the future, portfolio managers on Tuesday will now have to decide which stocks need to be sold and which issues they "really" want to own. The window dressing unwinding. Moreover, concerns over which companies might warn and which will have their earnings cut for quarters extending throughout 2004 will also be in the spotlight. According to Thomson First Call, the third-quarter ratio of negative to positive earnings pre- announcements fell to 2.2 versus 3.5 this time last year when the economy was clearly in a recession.
Time for some technical analysis. Beginning with a chart of the Dow, the objective this morning most likely was for a test of the July 24th low of 7532. After that, bears most likely looked for 7401 to be challenged, an area set during September 1998. Reasons for not testing the 7401 level included support from the regression line (coming in near 7460) and the chance that the RSI bullish divergence is a sign of a possible reversal. Other reasons could have been a self-fulfilling double-bottom and/or profit taking out of bonds and back into stocks.
Chart of the Dow Jones Industrial Average, Daily
Turning to the QQQ's, the much-discussed Head and Shoulders formation is still on track to meet its 17.64 objective. A move back above the ascending neck line (now currently near 22.25) will most likely nullify the H&S pattern. It is also interesting the that the RSI indicator failed to make a new low as the QQQ's continued its descent: A Bullish Divergence indicator. Note: Some necklines may be drawn different, resulting in an objective above or below 17.64.
Chart of the Nasdaq-100 Index (QQQ), Daily
The fixed-income arena shows extreme price action as well (see below). Looking at a chart of the 30-year bond, YIELDS have set a new record low monthly close and could possibly portend one more wave lower before recovery. Not coincidentally, the RSI is diverging as well. This divergence portends higher yields, which should be bullish for stocks. And, like the Dow, there is a good chance YIELDS will find temporary relief once the regression line is tested.
Chart of 30-year Treasury Bond Index, Monthly
To recap, the ISM report on Tuesday will garner much attention, as will price action within Treasuries and possible negative earnings announcements. Risk continues to be shifted into the bears' camp, but, as always, this does not mean that the selling will stop. As a trader, watch price action very closely and keep those stops tight. Who knows, maybe the Fed will surprise us before the week is out.