Priced to Perfection
Traders were wearing their rose tinted glasses on Friday and despite several bearish economic reports the markets closed up for the week and right at strong resistance. 54% of the companies already announced have warned about their 2Q outlook but those that have announced are mostly beating their lowered estimates. First Call has raised the overall earnings estimates to +10.2% for the 1Q compared to 8.7% just a couple weeks ago. Traders have quickly pushed up stocks to levels that assume the positive earnings continue. Warnings? What warnings? Do you want to borrow my glasses?
The economic reports continued to disappoint those looking for a glimmer of recovery on the horizon. The Jobless Claims soared to 442,000 and the second highest number for the year. Claims for the prior week were revised up as well. This was the ninth consecutive week over 400,000. The four-week average rose to an eleven month high at 425,000. Continuing claims rose +76,000 to 3.574 million. The rising trend of higher unemployment is likely to mean an increase in the unemployment number for April to something in the 6.0% range. Also, this is the week that is used to calculate the May Jobs Report numbers for April. The very high jobless claims for the three April weeks so far, -443K, -412K, -442K could indicate a seriously negative nonfarm payroll number in the first week in May. This would be the third month of massive job declines. One qualification, the shortened holiday week could influence the numbers to some extent either way.
The Philly Fed Survey fell again for April to -8.8 and makes the second declining month in a row. New orders fell to -11.2 from -4.3 and order backlog fell to -19.0 to -9.5. Employment fell to -12.5 from -8.8 indicating more weakness in jobs. Even shipments fell to -5.7 from 0.9 last month. This survey was taken before April 10th and the completion of the war is not yet priced in. The next month's numbers will be critical to see if the conditions changed.
The lower employment discussed above is being felt in various ways. United Health (UNH) warned that enrollment would be down in future quarters. UNH dropped -$5 on Thursday before recovering intraday. Multiply this type of unemployment impact across multiple sectors and it adds up to continued weakness. If unemployed consumers are giving up necessary healthcare you know they are already curtailing things like cars, computers and electronics. Gateway Computer reported a loss of -.62 cents after the bell on Friday and said computer sales had fallen by -30% from the 4Q levels. Gateway has shifted to a higher performance product mix and is no longer trying to compete with the cheap clones but is finding it difficult to find high dollar buyers. This was the ninth quarterly loss in the last ten quarters.
SUNW was the latest in the big box makers to report earnings this week and would not give any guidance going forward other than they expect "some" revenue growth. The CFO said they saw sales weaken from mid February and it continued into March. SUNW hit their earnings estimates but fell short on revenue due to the weakness in sales. The consensus is that SUNW will survive but not thrive due to heavy competition and a variety of high performance server choices.
The Semiconductor Book-to-Bill report was released on Thursday and the number remained flat at .99 from the original February number. However, the February number was revised down to .98. These are not critical numbers. As long as the levels remain close to 1.0, $1 of new orders for every $1 shipped, there will not be any further declines in the sector. Semis are treading water but not gaining any momentum. Considering some of the warnings in the semi sector this week this number could be seen as bullish except that it reflects March business instead of April. That March business is already reflected in the current earnings and warnings being reported. Confused? I think it is just another confirmation that business is flat. We will see some winners and some losers but no clear trend.
After the bell on Thursday there was a flurry of earnings and earnings news. EDS announced it was delaying earnings from April-23rd to May-7th to allow new management to get comfortable with the numbers before releasing them to the market. That could be exciting. LEXR Media, a chip company, reported inline with estimates with inline guidance. ISSX beat the street by a penny and raised guidance. XLNX beat the street and said revenue would rise by +1% to 5% and a little more than analysts estimates. Fairchild Semi (FCS) also beat by a penny but said revenues would be flat for the next quarter. IOM announced a drop in revenue of -40% and said even allowing for a difficult economic environment they were disappointed in the decline of their core products. ATML missed by two cents and warned for Q2. PMCS beat by two cents and did not give any guidance. BRCM soared +18% after saying revenue could rise +12% to +14% in Q2.
This mixed bag proves that the technology recovery is random and probably depends on having the right product and the right cost cutting strategies. It is not a broad-brush move and specifically related to companies with niche products.
Honeywell missed estimates by two cents and warned that full year revenues would be at the bottom of previous estimates. They said it was a very difficult market and they were being hampered by the freeze in the airline sector. UTX beat the street by two cents despite giving positive guidance just last week at the lower number. They then warned that they expect the business environment to remain difficult through all of 2003 but especially the 2Q. They affirmed their full year estimates but declined from giving any specific estimates for the 2Q due to lack of visibility. UTX dropped -2.27. NOK set the tone for Thursday with better than expected results overnight but the tone was very muted in early going.
The bottom line has been "no disaster". The warnings lowered the bar so far due to the impending war that almost everyone should beat estimates. Those that are missing were generally already expected to miss. With the outlook for the future now mixed compared to a previously bad outlook across all sectors we saw investors buying individual stocks on Thursday. Still there is a high degree of disconnect between the strong results and the economic climate. Cutting your estimates from 50 cents to 30 cents in March and then beating the 30 cent estimate by two cents in April is not a strong performance. It just means you over warned. This is what we are seeing and investors in general have a short memory. The "beat" becomes the focus instead of the prior warning that allowed them to beat.
It is all in the perception of reality. If many investors feel bullish based on the earnings for the week then the market will go up until those feeling bullish run out of money. Next week will give investors the chance to take another look at the economy and another barrage of earnings. 30% of the S&P have already reported and next week we will see another 30% report. Eight Dow components will announce. The economic calendar starts slow with only Leading Indicators on Monday and Chain Stores on Tuesday. Things pick up on Wednesday with the Beige Book and then Jobless Claims, Durable Goods, Help Wanted on Thursday. Friday has Home Sales, GDP and Michigan Sentiment.
Thursday's close contained several critical elements. First the Thursday before Easter has now closed bullish 8 of the last 10 years. That is a pretty strong historical trend. April has also been the best month for the Dow since 1950. The positive ramp into earnings has provided some interesting numbers. The VIX closed at 24.59 and a low not seen since June-3rd 2002. The TRIN closed at .50, bearish for a contrarian because it signifies larger ratio of up volume over down volume. The Put/Call ratio closed at .52, a level not seen on a weekend close for months. Remember, this was also an options expiration week. Volume was nearly 6:1 to the upside across all markets and 4:1 on the Nasdaq. This is very positive but this is also a normally positive Friday. The market is priced to perfection by any yardstick. Earnings are "better" than expected and the war is over. "Party on bulls!" appears to be the sentiment.
The challenges to the bullish scenario continuing to play out are many. They are not insurmountable and actually overcoming these challenges would put an even stronger bullish spin on the market. The Dow closed over its 200 SMA at 8332. This was heralded by some traders as a monumental event. The margin at the close was only 5 points. Technically a break but by a very thin margin. I would point to the chart below and suggest the EMA average at 8484 was more relevant. It has held all four times since last May.
Dow Chart - Daily
More importantly we have been going sideways in a narrow range between 8100 and 8400 since the March rally. The gains this week have put us closer to the top of the range but no closer to a major breakout.
Dow Chart - 90 min
While the Dow may be trending to the top of its range the Nasdaq closed exactly on it at 1425. This has been very strong resistance for the last two months. If we have a hope of breaking out of our range bound trading it will be with the Nasdaq. This 1425 level is critical but by no means the signal a new bull market has begun. Breaking this level will be one more step in the effort to break the current down trend. The next resistance is 1460 followed by 1500. That is liable to be a tough +75 point gain.
Nasdaq Chart - Daily
We continue to talk about the eventual danger of the VIX and the closing at a ten month low on Thursday should not be disregarded. It also does not mean a rogue comet will hit Wall Street on Monday. It simply means the risk of an eventual bout of selling is getting ever closer. The VIX could continue to drop to historical levels under 20 before the event but it would require several more days of very strong buying. What it is telling us is that there is little fear in the markets. Everyone thinks the markets are going up, or at least they don't think they will drop soon. The put/call ratio is another measure of lack of fear. At .52 it means the risks are balanced or neutral. The contrarian viewpoint would like to see more puts than calls as a measure of more fear. Something in the 1.0 or higher generally precedes decent rallies. Below .50 generally precedes a spurt of selling.
In the final analysis everyone was bullish on Thursday at the close. Whether it was the historical holiday bounce or irrational exuberance over the earnings surprises is not known. The markets rose almost casually despite the lopsided volume. We closed right at critical resistance on the Nasdaq and nearing critical resistance on the Dow. There are another 350 companies (guesstimate) announcing next week and historically the farther we get into the cycle the less impressive the results become. Also, the farther into the cycle the less interested investors become. We are a cynical bunch and bore easily. Oh, XYZ beat lowered estimates by a penny, yawn. Last week's earnings was a welcome respite from the depressing war news and the SARS epidemic. Will it prove the same next week?
With many companies already trading at significant gains over where they were a couple weeks ago I would caution against rushing into a buying frenzy. If you like BRCM at $16 when it was $12 a couple weeks ago then be my guest. Numerous blue chips have risen to resistance and getting enough momentum to clear that resistance could be tough. IBM at $85? INTC at $19? Citigroup at $39? CSCO at $14? MSFT $25.50? Without a breakout by these companies and others like them it will be hard to maintain a rally.
I would simply remind everyone that we are entering the historical worst six months of the year. Beginning in May many traders hang up their keyboards and turn to the task of family vacations, yard work and barbeques and don't return to trading until the kids return to school in September. The Hirsch Corporation, editors of the Stock Traders Almanac, issued a sell signal last Thursday based on market internals, technical indicators and historical trends. While I and most others I know scoff at the idea of taking a multi-month break there is a historical precedent that many do. While most of the readers of this article probably think this is the height of stupidity we all have to take that trend into account. To do this we should continue to profit from the bounces but be wary of rallies to strong resistance. Think of it as sprints for a runner. Run the race from every dip (8150) but when you reach the finish line (8500) be ready to take a break. No single race lasts forever. The start and finish lines can change at any time so be flexible and pace yourself.
Enter Very Passively, Exit Very Aggressively!