Another option expiration Friday has expired and traders were very eager to escape the week with no major losses. All the major indexes finished the week higher except for the transports, which lost some of the ground recently gained. It was a good week despite the repeated defeat at higher levels. Call it a consolidation week and chalk one up for the bulls.
Dow Chart - Daily
Nasdaq Chart - Daily
Wilshire-5000 Chart - Daily
If this week were a football game the economists would have lost. They had a lot of fumbles on bad news and each time the bulls recovered the ball and went on to score. The trend continued on Friday with the CPI headline number dropping -0.3% and the core rate holding at zero for the second month after only a +0.1% gain in February. Drops in energy were responsible for the larger than expected headline rate. The core rate has not seen two consecutive months of zero growth since the 1981/82 depression. No deflation? Tell that to the apparel makers after the eighth consecutive month of declines in prices for that component. Even the perennial rise in health care costs nearly broke even with the smallest gain of the year at +0.2%. The market reacted to the report with a gain at the open as the bad news bulls bought the potential for aggressive Fed action once again.
Also depressing the sentiment before the open was the -6.8% drop in Housing Starts in April. This was about twice as bad as was expected. If you remember there was a +6.6% gain in March which was unexpected and this simply reversed that gain. The prior month was a -10.3% drop in February. Homebuilder stocks had rallied on last months number and they crashed on Friday's news. The biggest decline was in multifamily homes. There was a big jump in permits which would indicate a strong jump in starts for next month. Given the lower mortgage rates this month and the prospect for even lower rates ahead this number should rise next month. Traders bought the jump in permits and ignored the drop in starts.
The biggest surprise for the day was the jump in Michigan Sentiment to 93.2 and much higher than the expected 87 and last months 86. The biggest jump came in the expectations component, which rose from 79.3 in April to 92.7 in May. The present conditions component actually dropped from 96.4 to 94.1 as relief over the end of the war waned. Current unemployment levels are depressing the present conditions component despite the gains in the market and the lower interest rates. Everyone has bought the second half recovery story hook, line and sinker and we are setting up for a major blow if that recovery does not come. Comments from Intel on Thursday about no recovery in sight appeared to be ignored. The bad news bulls did not know what to do with the good sentiment news and the market quickly sold off from spike to 8742. 8743 was the high for the year on the 12th. Coincidence?
There was some negative news on Friday that did not get bought. Prudential downgraded GM to a sell and joined the auto bears with comments that targets would be tough to hit, prices are falling and incentives are becoming more costly. They also hit the auto parts manufacturers like JCI, VC, GNTX and DPH on expectations of lower sales.
The big drop in the Semi book-to-bill on Thursday night pressured the Nasdaq but some semis drew "buy on weakness" comments from analysts. Traders faced with falling orders and a negative outlook were encouraged to load up. Dell was hit with downgrades on valuation and comments they were not bullish enough on their outlook, costs could not be cut significantly from here and there was only so much market share they could take from others without an economic rebound to fill the pipeline. Sometimes you just cannot win. I thought Michael Dell was not dodging the pointed questions very well on CNBC Thursday night but at least he did not say anything negative. Analysts saw the evasiveness and attacked like sharks on a blood trail.
Fund flow numbers from last week showed a -$67 million outflow from equity funds. Outflows after two weeks at new market highs? Yes, there is still no real conviction from retail traders. Bond funds were still suffering from overloads of cash but that should be about to change.
The U.S. may be an economic island of prosperity despite the current slump but it still depends on the world for consumption. Global economies are not healthy and with other countries already in recession it provides little comfort that the U.S. can avoid a similar drop. Current GDP numbers announced this week include Germany -0.2%, Italy -0.1%, Netherlands -0.3% and Japan flat at 0.0%. This is why there are increasing concerns about the Fed's coded mention of the "D" word in the last FOMC release. Surprise, it is not coded any more. Fed Vice Chairman Roger Ferguson came right out and put markets on notice that the Fed was on guard and ready to attack it in advance in a speech given Friday afternoon. Initially using the other "D" word, disinflation, he said "the possibility that the process of disinflation will cumulate to the point that price levels actually decline for a sustained period of time - that is, we enter into deflation - remains quite remote". He actually spoke the dreaded economic curse word. He said the Fed has to be on guard against such a development and preferred to act in advance of the event rather than in reaction to these economic developments. Analyst immediately were split on what their reaction should be. Should they be terrified that the Fed was now trying to prepare us for a period of deflation? Or should they be ecstatic that the Fed was going to act aggressively in advance to prevent the deflation from occurring. The speech hit the wires at 2:PM just as the markets were testing the highs of the day again and they quickly sold off into the close. Not seriously but they did sell off. There were also numerous large blocks of stock dumped in order on close transactions. 4.4 million in GE alone, an average of one million each of MSFT, INTC, KO, WMT. Somebody was definitely exiting large positions at the close. Bonds which had been selling off on the afternoon stock market rebound soared again pushing the yields to near the 45 year low for the week.
Next week should be really exciting. The comments by Ferguson on Friday would seem to either guarantee a rate cut by the Fed either at or before the June-24th Fed meeting unless the economy actually began to improve. Either way the conventional wisdom would indicate a bottom in sight. According to the Fed Funds futures at noon on Friday there was a 66% chance of a 25 point cut by the June meeting. That chance has definitely increased with Ferguson's speech. There was another news item on Friday that the St Louis Fed and the San Francisco Fed had requested a cut in the discount rate in March. All of these items combined to push bonds to an even higher high for the week.
Next week has almost no economic reports of importance. The only two being Leading Indicators on Monday and Treasury Budget on Tuesday. Neither of which are market movers. The weekly Jobless Claims on Thursday is a bigger mover than either of those. This means stocks will be left to move on stock news alone and there are almost no big name companies left to report. There are a few retailers on Mon/Tue with HPQ the headliner on Tuesday. CIEN leads the list on Thursday with ADKS, MRVL, SRNA and TIVO as the supporting cast. Definitely not a stunning week for earnings.
The markets will be left to chew on existing economic snippets and cuss and discuss the stimulus versus recovery potential. The bad news bulls will have no bad news to feed on and limited potential for good news. With no economics and no earnings and too early for earnings warnings it is possible the focus will return to global events. As I am typing this there are several new terrorist warnings for different countries overseas. The trail back to Osama has heated up again and they are saying the global risk is increasing. Personally I think without an attack in the U.S. the markets will not suffer. Traders have become immune to global news. They have almost become immune to U.S. news. This should be a sign to some that things are about to change.
If you read my wrap on Thursday night you know I am expecting an asset allocation shift out of bonds and into stocks soon. The ideal scenario was a consolidation pull back to provide the incentive for bond holders to feel better about taking profits and moving into stocks for the long run. I believe we are the crossroads and next week will be a defining moment for the markets.
The Dow came to a sudden stop this week at the downtrend resistance from last August at 8725. It has held at this resistance all week and put in higher lows on Thr/Fri. There is a very strong bullish wedge building on the Dow with weaker confirmation on the Nasdaq and S&P. Traders have been buying the dips with abandon and ignoring all bad news as pro stimulus good news. With a news blackout next week it remains to be seen if we will forge ahead or pull back to rest.
The VIX closed at a low not seen since last May-23 and just before the market began its long descent into oblivion. This May conditions are different. Prices are much lower, about 1500 points lower on the Dow. We are also well off our lows by 1300 points and three years into a bear market. Dead in the middle at down trend resistance. Time to raise, call or fold. Conditions are ripe for either direction.
Weekly VIX Warning
I view last week as a major win for the bulls. They held at new yearly highs and even managed to add a few points despite some very bad news. I think the market sentiment has changed. Trading volume is increasing, market breadth is increasing. There is not a lot of volume but there are simply no sellers. Despite the bad news this week and the negative markets on Friday the new 52 week highs were 562 and new lows only 26. This is a huge indicator of positive market sentiment even at these lofty levels. There may not be any conviction in terms of volume but there is definitely conviction in terms of breadth. Based on this updated $NYSI chart from last week they should be worried. This is the most extreme reading since Feb-1991 and should be a warning for anyone bullish.
NYSE Summation Index
Before I get too bullish I need to restate the bearish case for next week. We failed at the new highs for five consecutive days. The VIX is approaching the historical sell signal at 20. There is a very good case for a deflation spiral already underway. Intel's Andy Bryant said "I see no recovery in sight but I am hoping for a better 2004." IBM said technology was facing a tough time ahead even though conditions were stabilizing. Jobless Claims have been over 400K for thirteen straight weeks. Retail sales are in the tank. I could go on but you have heard it before. We are far from out of the woods but do traders really care?
Markets discount future events very well. We have seen it time and time again. When the last recession occurred in the 2Q of 2001 the market was already rebounding as traders looked ahead 6-12 months. It eventually came back to bite them six months later but the theory remains the same. Investors are always betting on the future and not the past. With the aggressive Fed, stimulus coming out of the Senate and company costs cut to the bone the odds are good they are entering the discount period again. The challenge remains timing. We are entering the weakest period of normal years in the May-September time frame. Will institutions wait for the end of summer for the typical September/October dip to spend the big money? OR, will they dive in immediately once the bonds begin rolling over? The odds are probably both.
I doubt we are going straight up and I doubt we are going to sell off very far. I think we may continue to be stuck in a range bound market between 8200-9000 until more economic data becomes available. Whoa! Big range. Yes, unless the bond market self destructs soon I think 8800-9000 is going to be a tough range to break. If we continue to get weak economic data the overseas money will continue to bleed from the market. Once really good economic news appears the starter gun will fire and we will be off to the races. Until then we are likely to remain stuck in the Twilight Zone below 9000. It may continue to be a buy the dip market but the dips could be lower soon. Dow 8500 should provide decent support unless the news turned really negative. The reason for the 8200 low end of the range is the tendency for markets to over react to sudden changes. Everybody may be bullish today but that can change in a heartbeat if the big boys decide to take profits and flush the weak holders out of the market one more time. While 8200 may seem like a long way off it is only a 38% retracement of the rally from the March lows.
In summary, I think the worst is over. Traders looking at a 3.5% before tax yield on ten year treasuries will soon be starting to think stocks are very attractive for the long term. If a +75 point gain for the week was the worst damage we suffered after a week of terrible economics then what else is in front of us that can make it worse. The Fed is going out of its way to assure investors that better times are ahead even if they have to buy them at a high price. In short, don't get your hopes up for a blow out rally next week but you can stop looking over your shoulder for that next lower low. Even though I hate the bond watchers always telling me that the bonds are the key to stocks, this time I believe they are right. If the bond bubble bursts the resulting explosion could be very good for option investors.
Enter Very Passively, Exit Very Aggressively!