Markets Topple Like a Statue
It was all about Iraq again this morning. With U.S. troops in the center of Baghdad, television cameras were pinned on jubilant Iraqis attempting to topple a statue of Saddam Hussein as an overnight sell-off in the equity market reversed back into the green. For a few hours, no one seemed to care that economic worries had sent a strong overnight signal that looked anything but bullish. The statue eventually came down, and so did the rally. It certainly looks as though the war speculation will be short lived, with a U.S. victory imminent. Let the haggling over how to split up the oil dollars begin.
With no significant economic releases this morning, today's activity gave us the best snapshot of just how the markets would react to a victory in Iraq, even though it has been assumed for some time that the U.S. victory would eventually come. The question had been, "At what cost?" While it was assumed the U.S. would eventually topple Hussein, we weren't really sure if there would be chemical and biological weapons waiting as we got closer to Baghdad. Apparently those concerns were answered as troops have suffered no attacks of that nature. the question of whether Saddam was dead or not has yet to be answered, although a mid- morning rumor that he had sought asylum at the Russian embassy turned out to be false.
The "end of the war rally" actually looked pretty weak. While the U.S. brass has said the war is not yet over, it appears that Baghdad has fallen and there are only small pockets of resistance left throughout the country. We are also about to start receiving first quarter earnings en masse in the next few weeks. Those numbers have already started coming in and so far they haven't been pretty. The fact that the war lasted longer than expected and extended right into earnings season can be seen a couple of different ways. First, it buys companies extra time for the excuse that spending is going to pick up after the war. Certainly investors can't expect those results to start showing up until next quarter and therefore we still have plenty of hope. After all, if the war had lasted three days and there was no improvement in spending trends, what excuse would companies have? This way they can release poor numbers but still accompany that data with hopeful guidance. The second way to view this is that a recovery won't come now until at least the third quarter, since hiring and spending have been pushed back by another few weeks. While the price of oil may eventually head lower, we cannot undo the damage that has been done by higher prices and the more companies had to spend on fuel, the fewer dollars they will now have to spend on new employees and technology. Did I say two ways to look at it? Maybe I meant two ways to spin the same negative outlook.
Let's not ignore the bullish possibilities, though. Maybe the theory that we will see spending pick up is valid. Certainly lower oil prices would help, but it appears that OPEC, which scheduled a meeting April 24, isn't going to let prices fall too far. OPEC had a hand in today's pullback, as well. The secretary general of the organization commented that there was plenty of supply on the market, further increasing speculation that the group would curtail production at that April 24 meeting. Saudi Arabia and others have been overproducing to make up for any possible shortfall that would result from the war and most likely also attempting to take advantage of elevated prices that might come down soon. OPEC would like to prevent prices from falling too far, since a robust supply and the lack of war premium might lead to a quick drop in oil prices. We also got news that the country's oil reserves had dropped unexpectedly last week. Right now the supply chain has been reduced by output reductions in Iraq, Nigeria and Venezuela and until the Iraqi oil fields are settled, OPEC still remains in control.
Equities have traded consistently inverse to oil prices and those comments form OPEC and news about the reserves coincided with both a rise in oil futures and a drop in stock prices. Of course, with the U.S. in control of Iraqi oil fields, it can always help drive prices lower through increased production. It is unlikely that the U.S. would move to disrupt the supply/demand structure and interfere too much with OPEC price controls, but we have proven that we are only so concerned with what the rest of the world thinks and if it takes increased oil supply from Iraqi oil fields to boost the economy before the 2004 elections, then I can certainly imagine a scenario where that occurs. However, for the time being, May Crude Oil futures bounced strongly from the rising 200-dma that has provided recent support. It will take some time to set up an Iraqi government and determine how the oil profits are distributed. We may see some big price fluctuations during that process. However, in the end, expect the supply to help, instead of hurt, the U.S. economy, even if the profits go back into Iraq.
Chart of May Crude Oil Futures
There are some sectors that should see immediate benefits from increased consumer spending. Airlines and hotels are a couple of the obvious travel-related industries. Many people have postponed planning vacations that involve flying either domestically or overseas and that should improve with the obvious celebration by Iraqis at the Saddam ouster. If the citizens of Iraq are glad to see the Americans, then the current level of global anti-American sentiment should at least not increase. Of course, the SARS virus still looms to disrupt travel to and from Asia, so until that situation is cleared up we may not see a return to pre-war levels. Wal-Mart, one of the world's largest companies, has banned corporate travel to Asia and the Government of Malaysia has banned tourist travel to China. Asian hotels are currently suffering single-digit occupancy rates, so we can't discount the effect of this virus on the industry.
The market internals derived from the point and figure charts continue to show an improving picture. The bullish percents continue to increase and we now have the Dow, SPX, NDX, COMP, OEX and NYSE bullish percents in rising columns of "X." However, with Monday's big intraday rally failing and looking like a blow- off reversal top, and the news all but done with the war, we will be left to digest those upcoming earnings and economic data. So far the data has shown a steady decline since the beginning of the year, with some of the data indicating a contracting economy. The ISM reports showed contraction in both the manufacturing and non-manufacturing sectors and the most recent jobs report showed the four-week moving average well above the 400,000 level that indicates a worsening labor market. However, if we look at the daily charts, we also see support at Dow 8200 finally cracking, as it did before the last dip. That was our previous line in the sand and had been again until today.
Daily Chart of the Dow
The initial rally on the Baghdad pictures this morning ran out of steam at a lower high than it did on Monday, and eventually faded back into the red as night fell in Baghdad. We took out the lows of Tuesday afternoon, after earlier taking out the highs. The Nasdaq Composite continued to underperform, as recent warnings from the sector have investors dumping some of these stocks ahead of earnings. The COMP not only dropped 26 points, but took out levels of support that were in place before the big gap up on the April 2 broad market rally. It began filling the gap early in the session and continued below that support, apparently headed for the next significant pivotal level at 1350. An upside earnings surprise from Yahoo (YHOO) after the bell could help halt the skid. The company beat estimates by 0.02 and also raised its guidance for the second quarter.
Chart of the COMP
One of the weaker sectors was the semiconductor stocks. The Semiconductor Index (SOX), which often leads the COMP, re-tested the pivotal 300 level, where it eventually failed. It has now set a series of lower highs and is once again testing support, instead of resistance. The RFMD warning apparently reminded investors that the pricing pressures and weakness in the sector could rear their heads in the earnings of the next couple of weeks. The SARS virus also continues to present complications for industry, as workers are quarantined and engineers stay away from Southeast Asia. The 50-dma sits at 294 and should be the next downside test.
The Dow saw its second major intraday bearish reversal in the last three. On Monday we reversed down 220 points from the high, while today we reversed down 191. While that's not decisive evidence that the recent rally is done, it is certainly not a bullish indication. WE now appear to be rolling over in a possible double-top formation in the major indices. The second top should actually be lower than the first, which it was in the Dow, but it was actually a little higher in the SPX and OEX. Still, it appears we have seen a "buy the rumor... sell the news" scenario. We also sit at a pivotal support level in the OEX at 440 and traders can keep their eyes on that average, which closed at 440.53 for signs of a bounce or continued weakness.
The Congress took an unconventional approach to budget approval today, essentially passing a plan with two different tax-cut plans. The plan will contain a $550 billion plan to be submitted to the House and a $300 billion dollar cut to be submitted to the Senate. It was essentially a away to pass a budget with a bottom line spending amount, but also allow for more debate between republicans and democrats on how much of the President's plan to implement. That doesn't sound like good news for investors looking for the elimination of the dividend tax. After all, if Bush couldn't get his plan through a Congress where both houses are controlled by Republicans, it can't exactly be considered an administration victory.
The IMF also gave us some data to digest and it wasn't good. The organization cut its global growth forecast for 2003 from 3.7% to 3.2%. It blamed a host of factors, including an average price for oil of $31 per barrel (which is higher than current levels). It also cited stagnant economies in Germany and Japan, a possible stock market bubble, a possible housing bubble, the spread of the SARS virus and a drag on European economies by social welfare programs. It lowered its growth estimate for the U.S. for 2003 from 2.6% to 2.2%.
If our end of war rally turned into a loss, it is hard to imagine what news will drive us higher. Positive earnings would be one catalyst; however, the pre-announcement phase doesn't look promising. Of the 1025 companies that have pre-announced, 202 have surprised to the upside, 225 have been on target and 598 have warned. The bullish percents are certainly in the bulls' favor, but what we saw today is not terribly bullish and appears as though we may have finally run out of steam. Common sense seems to indicate that if we didn't rally strongly today, there's not much out there that can still get us rolling in the short- term. Of course, a few well placed words about the U.S. opening the oil wells to the point of keeping energy prices down would help. While the war may be ending, the game has not.