An Empty Feeling
The markets continue their pattern of reacting to developments overseas. The weekend ramp up in the futures market followed through on Monday morning, as the March 21 highs were challenged throughout the major indices. The SPX and OEX both soared past those highs in early trading, while the Dow stopped a couple of points short. Iraq continues to deny that U.S. troops have entered Baghdad, in spite of tanks rolling through the streets and U.S. military planes landing at the Baghdad airport.
The other markets I've been using to confirm the equities all showed bullish confirmation - to a point. The Ten-Year Treasury Yield (which moves contrary to the bond itself and generally represents the moves in the stock market), jumped this morning and ran right into its 200-dma. That 200-dma level has come into play in the broad market indices across the board. The Dow, OEX and SPX all tested their 200-dmas last week and all eventually failed those levels. This morning's extreme bullishness, however, carried the indices through those levels at the open, with bears getting out of the way and apparently covering positions on the break. The 10-yr yield (TNX) was particularly interesting, as it failed to confirm the 200-dma breaks, when it ran into its own and then failed. It was on this failure (signaling an end to the asset allocation from bonds into stocks) that the equities began to pull back and traders got the first indication that the rally may not hold. Those pullbacks went so far that the 200-dmas wound up on top by the close and the patterns look eerily similar to those we saw on September 11 and December 2, just before big rollovers led the markets lower. However, the TNX failure wasn't the only driving force for the pullback.
Chart of the TNX
Chart of the Dow
We got a mid-morning report that more than a dozen U.S. soldiers had been evacuated from an Iraqi military compound after testing positive for exposure to deadly sarin nerve gas. Not only were soldiers contaminated, but so were two journalists and two Iraqi POWs, confirming the fears that the U.S. troops might be exposed to chemical and biological weapons once they got closer to the heart of the city. Later in the day, Donald Rumsfeld said that the tests had not been confirmed and that the substance could have been pesticide. The markets didn't seem to care. Troops also found what is believed to be am Iraqi storage site for chemical warheads. U.S. officials called the discovery a "smoking gun" and said soldiers found about 20 medium range rockets with warheads containing sarin and mustard gases. The news that soldiers were affected led to the pullback, while the potential discovery of a "smoking gun" brought back a bid.
The oil market, which has been trading hand-in-hand with the stock market, in an inverse relationship also gave us some clues about what to expect. One of the catalysts for the recent stock market rally has been the drop in oil prices. The May Crude Oil contract has been dropping, but continues to bounce from a rising 200-dma (there's that 200-dma indicator coming into play again). This morning's drop in oil on the U.S. advancement deeper into Iraq was short-lived. By the end of the day, May oil futures had fallen only 0.66 per barrel, in spite of the war progress. A mid-morning announcement that OPEC oil ministers would hold an emergency meeting on April 24 brought back bids. OPEC countries have been ramping up production to accommodate for any shortage that would result from the war in Iraq, with Saudi Arabia having upped production the most. There is now speculation that the organization will call for countries to reign in overproduction to keep prices from falling too far. That could put a crimp in the equity rally, as a long awaited drop in energy prices may not be as dramatic as many businesses are hoping. The rise in fuel costs has been one of the main contributors to increased wholesale costs and many companies have cited this as a reason for disappointing margins. The price of oil is already directly related to consumers' disposable income. Higher dollars at the pump mean less to spend in the retail markets and with consumer spending making up 2/3 of GDP, lower gas prices would certainly help any economic recovery.
Chart of Oil Futures
The news for the techs wasn't very good today, but the markets really didn't seem to care, as the war progress dominated the landscape. However, we should be paying attention to what we are seeing below the surface if looking to play anything in the mid or long-term. The SARS virus faded into the background a bit today, but First Albany published a disturbing note on the sector. The firm cut its growth estimates from +8% to -5%, saying it believes that the SARS virus will have a larger impact on the semiconductor economy than the war in Iraq. It said SARS is likely to have an incremental negative impact over the next couple of quarters that Wall Street models have yet to comprehend, noting that 70-90% of all PCs are manufactured in Asia. Reports of infections in that area of the world are growing, although the death rate remains in the 3-4% range. In the meantime, J.P. Morgan downgraded Linear Tech (LLTC) and Maxim (MXIM) based on valuations and cited long-term concerns regarding a slowdown in secular growth rates in the high-end analog market.
The airlines mostly got a boost today, with the possible end to the war leading more consumers to travel, but the SARS virus continues to affect this industry as well. Continental Airlines is the latest airline to cancel flights to Hong Kong and while not all carriers will suffer from a loss of those flights, there are plenty of international travelers from Asia that will not be making the trip to U.S. travel destinations. The hotels also got a boost, with Starwood (HOT) +$1.07 and Marriott (MAR) +$0.65, but if the virus doesn't come under control soon, the "end of war" euphoria may soon bleed into concern about the lack of Asian market travelers. The 180 cases in the U.S. are mostly due to travelers returning from Asia and the image of Asians walking around in surgical masks certainly can't be good for international travel. The most likely candidates to see a drop in business from SARS is any airline flying to the Asian continent, the reservation services such as EXPE and ROOM and the international hotel chains with locations in Asia. The CDC has said this version of the Corona virus is one that hasn't been seen before and is based on one strain of RNA, making it malleable and capable of adapting. However, Dr. Anthony Fauci, director of the NIH division of Allergy and Infectious Diseases, testified that the organization is already working on a vaccine. There is also some thought that the virus from which SARS is derived is most common in winter months and it could simply run its course. The airlines also will benefit from approval of $3 billion in aid, as part of the $80 billion war package that was overwhelmingly approved by Congress on Friday. While the $3 billion may help, the industry was looking for more than $7 billion and it remains to be seen if this will be enough to help the troubled carriers keep their heads above water. American is cutting domestic flights by 2% and international flights by 13%.
The Nasdaq Composite crossed a significant barrier this morning. The 1426 level is one that has led to much larger gains each time it has been crossed in recent months. It crossed over in late November on its way to its relative high of 1521 on December 2. After following/leading the broader markets lower throughout the month of December, it made another run through that level in January, stopping briefly at its 200-dma, before rallying back a couple of days later to a high of 1467. I say that level is pivotal because of the number of times it has reached that high and then failed. However, this morning's jump has to be called into question after it rolled over hard enough that it couldn't even hold support at 1400. What's more the COMP closed on its lows, with bears still pounding away.
Chart of the COMP
The U.S. dollar is the other indicator that has been giving us an indication of what to expect from stocks. As the war effort goes in the U.S.'s favor, it has rallied, signaling an inflow of cash into dollar-denominated assets, like stocks. This morning the dollar index (DX00Y) rallied to a relative high, just shy of 102. It failed at that 102 level on the last couple of rallies and dropped hard from the same level this morning. A move over 102 could signal some real legs for any rally. However, when we haven't been posting big victories in Iraq and have instead been faced with a troubled economy, it has sunk and has been declining since early 2002. By the end of the day, it couldn't even hold 101.00 and finished near its lows of the day as well.
Chart of the Dollar Index
Another indication of a pullback in the works came from the Market Volatility Index (VIX), which tested support at 30%. There was not enough institutional option selling to lower it below that support level, indicating that firms were not yet believers in the rally. A move back below the 29-30% range would indicate a rally has some life, at least until the VIX re- tests its relative low at 26%.
One of the biggest decisions traders face is judging whether or not to believe their eyes. Those looking at technical indicators saw a rising market this morning, which broke through significant barriers - namely the 200-dmas that have kept a lid on the broader indices for the past year. They were broken briefly on another similar occasion March 21st, when the markets were preparing for what appeared to be a quick end tot he war. When the war dragged on and we were left to focus on the economy, we saw a quick reversal down that found bids only when the U.S. made progress in Iraq again. It would be nice if a victory would suddenly turn the economy around. However, the economic data from the past week has indicated that the manufacturing and service sectors have dropped into contraction and the number of earnings warnings has outstripped the upside surprises. The danger of economic recession is still hanging over us and once the war is over, we'll have little else to focus on. The bet most bulls are making is that the economy will improve as businesses begin spending once the geo-political picture clears up. I'd like to believe in that theory, but so far we have no concrete evidence that it will happen. My general response is "show me the money" before I take an overall bullish view of the markets. That doesn't mean we can't move higher in the short-term. The bullish percents (stocks giving point and figure buy signals in an index) are climbing and we certainly saw rallies reach higher than the current levels in August, November-December and January. However, today's fade from the highs this morning and a rally that took place on relatively low volume leaves us wondering just how much gas the bulls have left. The post-war rally in 1991 gave traders a blueprint and it is possible that it started early, with market players trying to get in beforehand. The other similarities to those August, November-December and January rallies is the formation we saw at the top and that looks an awful lot like today's pattern. We have yet to see evidence of a large cash flow into stock funds and there is no evidence that the buyers in the current market are truly investors, as opposed to traders. Without investor money coming back in, the rally will be difficult to sustain. And with the economy contracting, there are fewer 401(k) dollars entering the market.
The fade from today's highs amounted to more than a 200-point intraday sell-off in the Dow. It's not the type of action we usually see on continuing rallies. We will likely continue to trade on news in the short-term. However, if today's bullishness could fade so quickly, then it appears that one of two things is happening. One - the threat of biological agents is serious enough to scare investors and put doubt in their minds about when the war will end; however, this seems unlikely considering the state of the Iraqi resistance. Two - We got our war rally a little early and the bulls have finally run out of gas, with just the economy to focus on now that the war is coming to a close. It wouldn't be the first "sell the news" drop we've ever seen. It was still a gain, but it didn't feel that way in the end. In either case, the feeling the bulls had this morning certainly vanished and left us wondering just what happened. And that sounds an awful lot like the feeling we got as the markets dropped over the past couple of years. Definitely not a feeling you get in a bull market.