Risk of Weakness
You could not tell it from the markets but the Fed is worried about the future. Traders appear unconcerned as all but the Dow traded to new highs for the year. Considering this was a Fed meeting day this was no small feat.
Chain Store Sales rose again last week with a +2.1% gain. This indicator has been very volatile lately and the gain erases the -1.6% loss the prior week. Analysts suspect advance sales for Mother's Day are providing the lift. (obviously not male buyers since there is still four shopping days left) According to analysts there is little pent up demand and no must buy items to attract consumers. Rising unemployment could also continue to put pressure on retailers.
The biggest event for the day was of course the Fed meeting. The Fed decided to leave rates unchanged but confused everyone with their guidance. They said recent economic reports had been disappointing but they mostly reflected prewar conditions. Since the war was over oil prices have fallen, consumer confidence has risen along with the debt and equity markets. The Fed felt these conditions along with the two years of prior rate cuts were enough to foster an improving economic climate over time. Great! Or at least that is what it appeared on the surface.
The second paragraph began with "the timing and extent of that improvement remain uncertain." This set the markets on edge and caused an immediate slump. Hidden in the middle of the second paragraph and in Greenspeak code was even worse news. "the probability of an unwelcome substantial fall in inflation, (code phrase for deflation) though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals is weighted toward weakness over the foreseeable future." In English, the Fed thinks there is a greater risk of deflation than inflation and they think the risk has increased for the economy to slow.
Great news if you believed the markets, which bounced to a Dow high of 8641 after the announcement was fully released. The Dow was up +110 after the Fed said the risk to the economy was stronger and were so afraid of the "D" word they would not even say it in the report. Eventually some concern filtered through and it sold off to zero before bargain hunters jumped into the fray. It was a very confusing afternoon. The Fed has been saying the outlook is picking up and the soft spot was firming for months if only the Iraq war was not cluttering up the geopolitical landscape. Ok, the war is over and now they are worried despite oil, confidence and a rising market. Just call me cynical but I think the rope a dope they are trying to pull on investors is about to tire.
They have set the stage to cut rates at the June meeting despite the falling dollar at four year lows. They would not do this if there were any other chance of success. The markets are showing the first real excitement in years and they are afraid to tank it by being truthful. I don't blame them but come on, "unwelcome substantial fall in inflation"? That puts an entirely new spin on Greenspeak. We can't use the "D" word the markets will tank. I guess the average investor probably does not actually understand the guidance anyway and this code phrase will just confuse those that do. Bottom line, the Fed is worried. They are in a box like Japan and very few weapons left in their monetary arsenal. They are hoping the economy will magically rise and save their butt just like we hope a bad optiontrade will magically reverse and turn profitable before the bid disappears completely. The three months of decreasing job losses has them hooked on hope. Hope that the trend is improving. Hope that the bearish flag on the Jobs chart will break to the upside instead of complete the bearish pattern with another drop. We have all been there and done that with our own money but I think the Fed is betting the economy on this because they have no other choice not because they want to. Here is the link to the complete release: http://www.federalreserve.gov/boarddocs/press/monetary/2003/20030506/default.htm
After the Fed excitement this afternoon the attention shifted to Cisco earnings. They beat the street by a penny and Chambers applied the spin. He said they were more optimistic about areas they had control. That means they feel they can cut costs again to make earnings if they have to. Obviously they have no control over demand and revenue other than giving the products away at fire sale prices. They said gross margins would be in the 68-70% range for the current quarter so they are not giving it away yet. Chambers said it remained a challenging environment and customers were remaining cautious. He said earnings would be flat for the current quarter on a possible minor increase in revenue. His outlook remained cloudy and he said he would not be surprised with an increase or a decrease in IT spending. To recap they beat the street by continuing to cut costs on revenue that was inline with estimates. CSCO fell slightly in after hours.
On the other side of the ledger ERTS blew away estimates and raised guidance substantially. ERTS posted 40 cents compared to estimates of 34 cents. They raised estimates for the full year to $3.10-$3.25 from the consensus of $2.96 a share. The company said they would have a breakeven quarter compared to an expected loss of -4 cents. The company said it was reducing console prices but expected to hold the line on prices on its major game titles. This company is doing well despite the economic dip and upstaged Cisco in the guidance department.
As earnings draw to a close the analysts and stock pumpers continue to point to the average earnings gain of the S&P of +13.2% for the 1Q as evidence the economy is doing well. They are predicting stronger gains going forward based on percentage increases of the 1Q numbers. There is a massive flaw here but it is not likely the bulls will care. The flaw is the massive ONE TIME gains by the oil companies due to the ramp up in oil prices prior to the war. Chevron posted a +131% jump in earnings, XOM +129%, AHC +64% and RD +98%. (RD is not in the S&P but used as an additional example) The oil companies have said the gains will not be repeatable and were a result of the war. If you take the energy gains out of the S&P the average gains for the 1Q drop to only +6.1% If the current rally was justified on the average S&P gain of 13.2% for the 1Q and extrapolations for the rest of the year, is it justified using 6.1% as the initial number? The current S&P profit estimates for future quarters based on a +13.2% Q1 are +13% Q2, +19% Q3, +22% Q4. If you consider 58% of the S&P has already warned for Q2 does that give you cause for concern?
It appeared to me that nobody was concerned about anything today. The Dow powered to 8641 and well over the 8600 resistance despite the FOMC meeting. It fell back at the close to just under this level but the uptrend is clearly in place. The Dow is facing even stronger resistance at 8700 and again 8800 but nobody appears worried. The NYSE posted a very strong 244 new 52-week highs to only 6 new lows on volume of 2B. Definitely some conviction finally beginning to show.
Dow Chart - daily
The Nasdaq was even more impressive. With CSCO earnings looming over the tech sector the index soared to a new eleven month high at 1531 and held most of its gains. The good news from companies like ERTS is continuing to power tech investors and they are coming off the sidelines in droves. The Nasdaq traded 2.106 billion shares, a record for the year, with 3:1 up volume to down. New highs hit 228 compared to only 17 new lows. Above 1521 there is very little clearly defined resistance before the 1800-2000 level. I seriously doubt we are going anywhere near there any time soon but anything is possible. There is token resistance along the way but nothing as serious as that recently broken.
Nasdaq Chart - Daily
It all boils down to where do we go from here? The Fed is worried about the "D" word and hoping that the three months of job losses was a war related event. The Challenger Layoff report for April, which was announced on Monday jumped +71% over March levels with -146,399 reported. The Challenger report covers ANNOUNCEMENTS of layoffs and those layoffs are normally done over the following 60-90 days. That makes it a leading indicator of future trends. The continued rise in Jobless Claims, which has been over 400K for the last 11 weeks is also a current indicator. The average for the last three weeks after the war was -452,000 jobs. This continues to paint a serious bearish divergence to the current market action. The markets are on a roll and fundamentals do not matter. If the reaction after today's Fed meeting is any indication the buyers may not be done yet. With the markets setting new highs nobody wants to be left out. The increased volume today, of all days, shows that the conviction is growing. Now that the majority of earnings are over and the Fed statement has been cussed and discussed we will need to see if the buyers continue to appear.
Bears are stumped. They are shocked and in disbelief at the gains and are continuing to short every resistance level. However there is a little less conviction with each bounce. The indexes are all at the top of their uptrend channels and are strongly overbought. The VIX hit a low of 22.47, a low not seen since May of 2002. May 17th 2002 was the last relative high over 10,000 at 10353 and the Dow closed over 10,000 for the last time on May-24th. That bullish high on the 17th preceded a massive -2800 point drop to the low of 7532 on July-24th less than 45 trading days later. The stage is set. Are we set to repeat the May-October swoon? Will the bulls manage to keep the rally alive? The only economic report on Wednesday is Wholesale Inventories and it is not likely to change the sentiment. The only thing that will change sentiment is a couple days of declines and a Dow close under 8400. Until then the uptrend is still intact and the dip buyers are alive and well. With very strong resistance at Dow 8700-8800 they will have to find help. Who knows, maybe the recent gains came from Saddam investing his $1 billion cash withdrawal they have been reporting all day.
Enter Very Passively, Exit Very Aggressively!