Bad News Rally
It was a great Friday. Bad news was breaking out all over and investors were celebrating by going long. A seven-month low in Capacity Utilization, two year high in PPI, Industrial Production down -0.8%, warnings of spectacular terrorist attacks in the pipeline and the markets closed near the highs of the day. All we need now is a rogue comet on collision course with earth and Dow 10,000 should be a sure thing.
Dow Chart - Daily
Dow Chart - 30 min
Nasdaq Chart - Daily
Economically it was not a good Friday. Business inventories increased faster than expected at +0.5% but analysts were not sure if it was due to slower sales or a buildup for the holidays. The period covered was prior to the dock strike and the buildup could have been an attempt to beat the anticipated strike.
Things got worse with the Industrial Production which fell -0.8% and much worse than the -0.3% expected. This was the third month in a row that all components of the index declined. This was also the biggest drop since September of last year. Durable goods production dropped by -1.2% and autos fell -5.2%. This is clearly a major problem and is a strong argument for a new recessionary double dip. Many think this was the smoking gun that prompted the Fed to cut rates so drastically. Capacity Utilization fell to 75.2%, a seven-month low, and not far from 20 year lows. This means companies have no pricing power and excess inventory is being produced just to keep plants from being shuttered. This depresses prices even further as price cut incentives are used to beat the competition and turn the excess inventory.
On the other side of the coin the PPI jumped +1.1% and well over 0.3% expectations. Energy prices and an increased cost of core materials are finally being felt in prices. This inflation, while far from critical, will give the Fed something to fear if the trend continues. With the excess liquidity in the system and the recent 50 point rate cut the Fed will not be happy to see inflation spiking so rapidly. The number actually spiked the Fed funds futures for December to an 8% chance of a 25 point tightening. While 8% is not a strong chance it is proof that new inflation worries may need to be acted upon quickly. Given that the majority of the increases were due to energy I think the Fed has a long time to wait before needing to act again.
The best news of the day was a spike in Consumer Sentiment in the preliminary number for November. The number jumped to 85.0 from 80.6 in October. Sentiment had declined for five consecutive months and the gain today nearly offset the October decline. Consumers do not seem to be concerned about Iraq and the stock market appears to have bottomed in October. The bounce could have just been an over reaction from the election, the rate cut and the capture of the sniper. The real problem for consumers remains unemployment. As seen by the +89,000 rise in continuing claims this week that problem has not gone away. Consumer sentiment should continue to rise slightly as typical holiday cheer begins to impact the numbers. Desperation sales by retailers will help stretch limited budgets and that will improve spirits. The fed rate cut will allow for one more round of mortgage refinancing and consumers will likely jump on that as a way to fund holiday buying.
It appears they will not be buying computers. The Gartner Group lowered their estimates for growth in PC demand to only +1.1% for the fourth quarter. This barely breakeven number is even worse when you add in the current price wars underway. There are new desktop computers being advertised now for under $200 which shows the lack of demand and the lack of profits in the retail sector. My unofficial price check on components showed 512MB 333 MHZ DDR ram down to $133 a stick. This was over $200 three months ago. This is what we use in our high-end processors. I bought four 120GB IBM Deskstar 7200 RPM disk drives on Friday for $146 each. I paid $229 for the same drives 60-90 days ago. If we wait long enough Gateway will be throwing in a $1000 flat screen HDTV with every $995 desktop computer sold. The fact remains prices only drop this fast due to over capacity and very low demand. Think about it. In order for chip and computer manufacturers to break even on revenue each quarter they have to sell 35% more product to offset the 25% drop in price.
The wild card for consumer sentiment this month is the new warnings from the FBI. They warned of a new and spectacular terrorist attack possible in the immediate future. They said Al Quaeda was likely to be planning a very high profile attack on high profile targets. The target could be of high symbolic importance and after the success in impacting the stock market on 9/11 they think they could target the financial system as well. Malls, sporting events, power plants, railroads and hospitals have been mentioned as possible targets. Many think Osama risked going public with his survival this week in order to trigger sleeper cells to act on plans already in place as the holidays approach. Since everyone thought he was dead the heat to find him had diminished. By going public he took the spotlight again and restarted that search. Analysts think he took that risk only because he had to do it to launch the next set of attacks. If an attack occurs at a mall or sporting event the bouncing consumer sentiment will be history. The good news? The market ignored the warning and business continued as usual.
It appears the markets have shaken off all the bad news possible and are determined to forge ahead. High profile downgrades on Friday of GE, DE, INTC, DELL, ADI, AMCC, CNXT, PMCS, MERQ, BEAS, FDX, GILD, CEPH, NBIX, ACS, XMSR and FBF to name a few, failed to tank the market even with the negative economic news. Investors have been hearing how bad it is for so long it appears they may just be ready to bite the bullet and buy stocks. With money market funds not paying enough interest to justify letting them hold the money, investors may be shifting funds back to stocks on the hopes that the worst is behind them. Mutual funds have seen inflows of cash for two consecutive weeks and now they have to spend it. Fund managers are faced with competitive pressures. If other funds are buying stocks then they must follow suit regardless of their bias. They can't afford to let the competition get ahead of them in the race for investor results.
The markets actually broke out to new highs for the week at the close. The Dow broke two resistance levels of 8500 and 8550 on its rebound and the Nasdaq is very close to the quadruple top of 1425 that dates back to the first breakout attempt on August 17th. A break of Nasdaq 1425 could energize the other indexes and power them past resistance as well. With the Nasdaq being the strongest index this week and no material profit taking Friday on lots of negative news it appears poised to test that 1425 level on Monday. Next week is slow economically and has few earnings events. Investors will be gearing up to be consumers as Thanksgiving kicks off the holiday shopping season.
Negative economic news, bad earnings and downgrades have all failed to knock the markets back to October. Assuming there are no spectacular attacks to test our resolve there is little on the "surface" to prevent the markets from moving higher. However, we all know from experience that when things look the brightest disasters tend to happen. The biggest fear for investors this week should be of a roll over by the Dow at 8600-8650 to complete the right shoulder of the current pattern which could stop this rally cold.
The week before Thanksgiving has produced gains for the S&P-500 nine years in a row. Nobody can guarantee that that streak will stretch to ten but most of the bad news has already been factored into the markets or at least that is what analysts appear to be telling us. According to them the biggest risk facing most investors is not a terrorist attack but not being in the market if an explosive rally occurs. While I would applaud a breakout over current resistance levels I would caution you that we need to see those levels broken (Dow 8650, Nasdaq 1425) before betting the holiday shopping budget by going long.
Enter Very Passively, Exit Very Aggressively!
"No profession requires more hard work, intelligence, patience and mental discipline than successful investing. - Robert Rhea