Time to Wake Up
Sell the news! That appeared to be the theme to this morning's trading, as bulls got what they wanted when republicans took over the Senate. Investors were hoping for this development, as it should lead to more permanent tax breaks and a friendlier environment for big business. That being said, the initial boost led to profit taking after the pre-election rally.
Some of the big winners were defense stocks, which are likely to benefit from the GOP taking control of all three branches of office. Republicans generally raise the defense budget, and with President Bush leaving little doubt that he would like a regime change in Iraq, there should be little Congressional opposition when the time comes to send in the troops. The defense indices, DFI.X and DFX.X posted gains of 21.47 (4.07%) and 6.51 (4.13%), respectively. The group's big gainers were Northrop Grumman (+3.92), L-3 Communications (+2.24), General Dynamics (+3.32) and Alliant Techsystems (+3.45).
As the day wore on, the market went into a holding pattern ahead of the FOMC rate announcement. The general feel was that the FOMC would cut rates by 25 basis points, leaving the Fed Funds rate at 1.50%. A 25 basis point cut would not have left much room for additional moves, to deal with a further stagnating economy and possible terrorist attacks. Furthermore, recent comments from past meetings seem to indicate that the Fed Governors saw a slowly growing economy, in which rates were already at stimulating levels. However, the feeling was that the economy needed a bit of a boost and if the FOMC did not cut, the markets could crash hard. Therefore, those firms calling for a 50 basis point cut at this meeting appeared to be smoking something other than tobacco. The fed funds futures were pricing in a 25- point cut, with a slight possibility of another at the December FOMC meeting on December 10.
Little did we know what the Greenspan clan was planning - a 50 basis point cut that was the result of a unanimous 12-0 vote of the FOMC. Sounds pretty bullish for the markets, huh? Not so fast. The FOMC statement that accompanied the reduction stated that, "incoming economic data have tended to confirm that greater uncertainty, in part attributable to heightened geopolitical risks, is currently inhibiting spending, production, and employment." The committee basically telegraphed serious concern about what they called a "soft spot" in our economy. They blamed heightened geopolitical risks (read: Iraq), which certainly have had some effect on companies reluctant to do business in that part of the globe, as well as concerns over fuel costs. However, the rough employment picture seems more based on a lack of business spending in the economy, which has also led to contraction in the manufacturing sector. Now that the bullets are out of the gun, it will be interesting to see how the fed deals with future economic weakness. While it is possible to lower rates further than the current 1.25%, there is not much room to move before money essentially becomes free, when taking into account the inflation rate. The fed addressed that concern by stating, "Inflation and inflation expectations remain well contained." The committee also said it believed that the risks are balanced for now, in regard to long-term goals of price stability and economic growth. This indicates they are not planning any more changes in the near term.
We usually see a dramatic reaction following rate cuts, at least intraday. Today saw no such reaction, as investors took time to digest just what the cut meant. Was the FOMC giving the economy a big shot in the arm that is likely to lead the market higher? Or was the committee telling us that things are absolutely terrible and they are going to try to loosen up some cash ahead of the holiday spending season? Without any real market commitment, it seems that no one is exactly sure. The answer is most likely both. Today's reaction saw a boost, and then a dip and then a methodical march higher. Bulls can feel good about the Dow breaking through the next resistance level of 8750, which was the shoulder level on the H&S pattern formed from July through September and also provided resistance the last couple of days since breaking through 8550 on Monday. We are seeing a consistent pattern of rallies followed by consolidation, followed by another rally. While the 50 point cut did not send the markets off to the races, the grind upward remains in tact. Today's high of 8800.00 gives us the next intraday upside breakthrough target for bullish confirmation.
Chart of the Dow
The Nasdaq followed a similar pattern to the Dow, with a dip following the rate announcement, which eventually turned into a gain of 17.82 by the end of the day. That gain looked likely to carry over to tomorrow's open after networking giant Cisco beat earnings estimates by a penny after the close. The company's revenues rose 8% from the year-ago period and surpassed expectations slightly, as well. Cisco was trading as high as $13.60 after hours, up $0.63 from the closing price. However, the stock topped out and pulled back to $12.80, below the day's closing price, as the company revealed that 2nd quarter revenue would be sequentially flat to down 3-4%. The Nasdaq Composite is actually testing its August top and tomorrow's action should be a test of whether the recent rally can set a higher high. The NDX has already accomplished the higher high, and often leads the other indices. However, after hours it had pulled back, along with Cisco. If the pullback in Cisco turns out to be evidence of a last gasp to the rally, then the August highs were the true test and the intermediate bounces take on less importance. If the Nasdaq actually shakes off the forecast, and takes out the August high, then there is no reason to believe the Dow cannot attempt the same feat. If a Cisco warning doesn't spoil the party, then I'm not sure what can.
Chart of the Nasdaq Composite
Chart of the NDX
We continue to hear that IT spending has yet to turn around, so the current rally seems misplaced. However, there is no arguing that we are in rally mode and traders should go along for the ride until the tide turns. That tide could turn on a single sell-off, so we need to be very nimble and loyal to our stop losses. The Cisco "pseudo-warning" could lead to that sell-off, but for the last month the markets have shaken off the bad news with amazing strength. The last time we ventured into this territory the Dow kept going to 9077, before turning around and sinking below its July lows. We are still in a bear market and thus any rally should be considered of the intermediate type. This means that the current rally is still against the broader tide and longs need to be careful. Market internals seem to be favoring a continued rally, however, with the bullish percentages of the Dow, Nasdaq Composite, NDX, OEX and NYSE all now in bull confirmed status.
One of the less talked about factors affecting businesses is lower fuel costs. For all the talk of OPEC not raising quotas to ensure the world's oil supply continues if the U.S. invades Iraq, the 11-member group has largely ignored its own quotas. OPEC pumped more than 3 million barrels per day in October, which was 15% more than their limit. OPEC president Rilwanu Lukman only half-heartedly criticized the quota busting, saying, "It's alright now in the fourth quarter and first quarter, maybe the market will tolerate (over-production), but come the second quarter unless there is a strong shift in demand there may be less oil required in the market." The price of crude oil in the futures market has dropped steadily from close to $31 per barrel at the end of September, to under $26 per barrel at the close of business today. The ongoing debate in the U.N. seems to have pushed off Iraqi invasion plans in the short-term, but a little tough talk from the administration could quickly send oil prices higher once again.
Chart of Crude Oil Futures
The chip stocks got a big bounce today, after successfully testing support at 300 in the Semiconductor Index (SOX.X) yesterday. Like many of the other tech sector indices, it is still steadily climbing after the August through September sell- off resulted in multi-year lows. There has been no real change in tech predictions, as IT service provider Computer Sciences (CSC) lowered its 2003 outlook, citing slow spending. Here is a look at the SOX, as well as the Software Index (GSO.X) and Hardware Index (GHA.X). They have all been steadily climbing through resistance levels and show no sign of slowing. It is hard to believe that they can continue the run without a spending increase, but with rates lower, investors may be hoping that the reduced cost of financing leads to a reversal in that trend.
Chart of the SOX
Chart of the GSO
Chart of the GHA
SEC Chairman Harvey Pitt resigned last night. Pressure mounted on Pitt as a result of his pushing William Webster as his choice to head the SEC's accounting oversight board. Webster had been involved in an accounting fraud suit based on activities at U.S. Technologies, where he was part of a 3 person audit committee that voted to dismiss outside auditors in the summer of 2001, after the auditors raised questions about the firm's internal financial controls. The company is all but insolvent and is facing multiple shareholder suits claiming they were defrauded of millions of dollars. Pitt failed to share this information with the White House and other members of the commission and calls for his resignation have come on a daily basis since Webster's involvement was revealed. Webster had shared this information with Pitt, but was assured it would not be a problem. Oops.
Tomorrow's trading should give us a good gauge of the next trend. After the election, the surprise 50 basis point rate cut and the news from Cisco has a chance to digest, we'll get a feel for whether investors will continue to buy, in spite of continued tech warnings, or if the Fed has soothed all fears. Look for intraday support over Dow 8750 and a COMPX breakthrough of the August high of 1826 to signal continued strength. If we get a tech pullback, then watch for the beginning of a continued retreat. It is not often we get so much news accompanying crucial market support/resistance levels, so if you been sleeping in class, now's the time to sit up and pay attention.