Picnics and Taxes
Friday was another humdrum day with the averages ending only fractions from old support levels. Thoughts were on picnics, taxes, racing, golf or just three days away from the market. After the market closed I discovered that the day was not as boring as I thought, which leads me to believe that next week could be exciting.
Dow Chart - Daily
Nasdaq Chart - Daily
There were no material economic reports on Friday with the Weekly Leading Index ticking only slightly lower due to lower bond yields and a drop in mortgage applications. The six-month projected growth rate did rise to +3.2%. This matches several high profile estimates this week for growth in the second half of 3% to 4%.
Another obscure economic report showed the Internet E-commerce sector continued to expand rapidly in the 1Q with $11.9 billion in sales. This represented 1.54% of all retail sales and showed an almost imperceptible dip from the 1.59% 4Q rate. This was the second highest quarter ever and not normally a strong quarter. The growth rate slowed but the sector is continuing to expand. The news powered YHOO and NTES to new highs for the year but did not help EBAY, AMZN or BGP, which you would have thought would have benefited from the news.
The big news for the day was the final vote on the tax cut bill by the Senate. We got a final burst of buying on news and dividend stocks added another round of gains. Utility stocks like FPL gained +2.59 on the news. A $50 stock paying a $2.30 annual 4.6% dividend yielded +2.6% after taxes under the old plan. Under the new plan that after tax yield jumped to +3.9%. Even Altria gained another +1.26 to $42.30.
Microsoft CEO Steve Ballmer announced he was selling some of his 471 million shares. He did not say how many but most commentators believe he had to go public because of a 70 million share block that has been shopped all week. Rumor had it that one of the eight largest shareholders was making the sale. Odds are now good that it is Ballmer. He said this was part of his diversification program. Another Microsoft billionaire, Paul Allen, announced he was cutting 20% of the staff at Vulcan Ventures due to the slow economy. Puts a crimp in the net worth when your majority of your stock holdings were in a $60 stock (presplit $120) that is now selling for $24. If Steve and Paul need help adjusting to a lower lifestyle I am sure Ted Turner is available for a price to consult. His $100 stock is now trading for $14 without a split. That is a painful $8 billion loss. Brings new meaning the term grumpy old man.
Speaking of fortunes lost, Union Finance and Investment filed suit in Los Angeles against Michael Jackson claiming he is near bankruptcy. The 44-year old singer has reportedly blown through a $500 million fortune and has been living on a line of credit for months. Jackson is said to be sitting on nearly $500 million in song rights including 200 titles from the Beatles, Elvis and other top stars. However, he reportedly has no income after the sales of his recent albums fell flat. Michael Jackson broke? Toto, we really are in never-never land.
The big three automakers came under pressure after Goldman Sachs said the companies will post disappointing results for May and cut production by 10% in the 3Q. They said negative headlines about sales and production cuts and high inventory are likely to weigh on those stocks. Incentives are having to be increased and sales are slowing while inventories are expected to be as much as +35% above normal levels.
Another vehicle maker landed a huge $16 billion deal to lease tankers to the Air Force. Boeing will lease 100 modified 767 jets to the Air Force as aerial gas stations beginning in 2006 and adding 20 planes a year for five years. The lease has a $4 billion purchase option at the end of the lease for a total of $20 billion. The planes could have been purchased outright for $8 billion. Needless to say there has been quite a controversy over the big difference in price. Personally I think there has to be something not visible on the surface to justify the difference in the price. Do the leases included any maintenance, insurance, upgrades, etc. Enquiring minds want to know why BA got such a sweetheart deal.
If you looked at the close on Friday with the Dow +7, Nasdaq +2 and the S&P +1 you would have a very wrong impression of the day. With the markets finishing basically flat you may be surprised to learn the advances beat decliners severely 4489 to 2731 across all markets. Even more remarkable was the new 52-week highs which came in at 660 compared to only 47 new lows. This was in a week where the major averages lost ground instead of gained it. The 660 new highs was the largest reading of the year. You could easily form two entirely different opinions about next weeks market direction, maybe three. If you just looked at the rounding top rebound on the Dow from the last two days and seeing the flat close on Friday you would think we were about to start the next leg down.
If you looked at the internals I mentioned above you should be pounding the table making the case for the bulls. If you are a technician the VXN close at an all time low of 29.73 on Friday with the VIX at the second lowest close for the year you would be backing up the truck to load up on puts. I kept seeing the potential for Mark's MOPO event behind every tree.
The economy is not well but everyone says it is getting better. You can believe the economic reports or the spin doctors or ignore them both and just go with the market. The Feds would have you believe the economy is poised to explode in the 2H but that would need a jump in consumer spending. With unemployment rising and benefits expiring there are about to be 2.5 million workers with no jobs and no income. Jonathan sent me this chart today. Note that since 2001 the unemployment rate has risen +50% from 4% to 6% and in the same period consumer debt has increased over 10% in percent of the GDP. With employment still dropping there are two choices. We will either have another huge spike in debt as the unemployed live off their credit cards prior to bankruptcy or the rate of consumer spending will slow substantially. Neither is market friendly.
I mention this because it runs completely contrary to the current market trend. The markets are moving up like the recovery is guaranteed.
Friday was a slow news day and the research urge hit me once again when I saw the bullish internals. I have shown these charts before but since this is the critical date I feel the need to show them again. The top chart is the S&P for May of 2002 compared to the bottom chart which is May-2003. The comparisons are simply amazing. Very seldom does history repeat itself so closely. Same dips, same peaks, same trend, same VIX.
S&P Charts - May 2002/2003
The $64 question is what will happen next. In 2003 the pre Memorial day dip bounce was the first in a series of painful dip/bounce patterns as we drifted into summer. The charts below illustrate that pattern.
S&P Charts - June 2002/2003
There are many differences in the underlying markets. The May-2002 new 52-week high/lows were split 50/50 at about 200 each, not 660/47! The Q1 GDP was only 1.3% when reported in May-2002. Oops, Q1 is only expected to be 1.6% next week! Ah but, Q1-2002 GDP was 5.0% so the drop from 5.0% to 1.3% was a real shock. Going from Q1-1.6% to Q2-1.6% in 2003 should not be such a shock to the system. The unemployment in 2003 has seen three months of losses for more than 500K jobs. Sounds pretty grim for the 2003 outlook. In May 2002 there was an explosion of new jobs, +41,000. That may not sound like much but after eight straight months of job losses ending in March-2002 totaling -1,260,000 jobs that +41K number was a breath of fresh air. The ISM in April-2002 was 53.9 after climbing out of a hole in Oct-2001 under 40. In 2003 the ISM for April was 45.4 after falling from a high of 55.2 in December. The Dow was 10350 the week before the holiday in 2002 and only 8743 in 2003. Interest rates had already been cut to 1.75% in 2002. Oil in Q2-2002 was $28, today $28. Confused yet?
The differences between May-2002 and May-2003 are vast in some numbers but not really that different. The GDP is about the same at +1.3%-1.5%. The unemployment is coming out of a 3-month hole in 2003 and an 8-month hole in 2002. The ISM was rising in 2002 and falling in 2003. The markets were 20% higher. Earnings were falling in 2002 and despite massive cuts in estimates for Q1-2003 a full 55% of the S&P have already warned for Q2. Interest rates are only 50 basis points lower now than then. The tax cut passed this week was the third tax cut for this administration in three years so that factor is also mitigated. If anything 2002 was in better shape than 2003. What is it that is different?
I listen to talking heads all day long that say the market is going up for this or that reason. I personally see several that I believe are powering this rally. First I do not see a recovery yet. It may be coming but the signs are so faint that it would take a stethoscope to hear them. Two of the major factors which are powering this market are bonds and sentiment. The yield on the 30-year was 5.75% in May-2002. The 30-year closed at a new 45-year low on Friday at 4.25%. Even more amazing is the 10-year at 5.25% in 2002 and 3.33% today. The after tax yield is even lower. Greenspan was quizzed severely this week about the impact of another rate cut on the money market industry. At what rate do they begin losing money and how long before the industry implodes. He said the Fed had spent considerable time and research in trying to determine that impact but gave no answer. With financial rates so low there is simply no incentive for retail investors to park money in stagnant accounts.
That brings us to the second reason, sentiment. The market was supposed to go up. That is what investors were conditioned to think. We won a war and the threat to peace has vanished. They can look back to 1991 for a quick history lesson and pattern for the market. The economy was coming out of a soft patch then and again now. Technology triumphed over evil and the retail investor voted with their dollars. Did it make economic sense? No, it was sentiment, plain and simple. The economic cloud was lifted. Is this a justification for continued investment? No, but then retail investors do not need justification. They normally vote with their emotions.
Traders tell me the market can't go higher because the economy is in the tank and dropping. Others tell me that the second half recovery is going to power the techs to huge earnings gains. I agree, just like the second half recovery of 2001 and 2002. If it come it will power them to huge earnings because of significant cost cuts just to stay alive over the last two years. Is it coming? Intel, Cisco and Microsoft all said "no recovery in sight" in so many words. If companies were taking bids for infrastructure components for the second half, which is only 25 trading days away if you are counting, then these big tech companies would be seeing those bids. If you are GE you don't just call HPQ and say I need 150,000 PCs and here is how I want each of them configured and where I want each one shipped. Can I get a price tomorrow for shipment on June 15th? The procurement process for any orders of scale takes months of details, bids, adjustments, rebids, etc. Let's be generous and just say the odds are slim for any major change in the 3Q. Not impossible, just slim.
That puts us back to what now and why. Can May/June 2003 end up like May/June of 2002? Maybe. The only two major components that are really different are bonds and sentiment. Investors are thinking "what is my risk?" Leaving the cash in a money market is about as profitable as a mattress. The markets have rebounded +20% but so what. Stocks are rising from the dead. Lucent hit $2.50 after trading at 55 cents. BRCM is $22 after trading under $10. JNPR is $13 after trading at $4. EBAY $100 and YHOO $28.50 are setting new 52-week highs. YHOO was $9. Retail traders see this and instead of thinking "I will wait for the summer pull back to buy some" are instead thinking "I have to get YHOO before it breaks $30."
Fund managers are buying in self-defense. If XYZ fund performs better than me I could lose my bonus and/or my job. Yes, the market should trade lower during the summer but what if I wait and it doesn't? I could be fired. They cannot afford to wait in cash or bonds with the markets continuing to move up. I am not saying they wont be the first to sell if it begins to roll over but right now they have to buy in self-defense.
Even the conservative funds are being forced to buy. Have you seen the dividend stocks this week? You cannot tell me a million retail investors suddenly got the urge to buy Florida Power and Light (FPL) today. Funds bought it because it pays a big dividend and it is stable. With the ten-year treasury yielding 3.33% they are not going to win many customers with their end of quarter statements. With only 25 trading days left in the quarter they are in a pinch.
There is an estimated $5.5 trillion in cash and money markets that is waiting for a sign. Next week begins the road signs for May. The economic calendar was nearly void this week but the wait is over. The battle cry of "it takes May data to play" is about over. That May data begins on Tuesday with Consumer Confidence and Home Sales. Wednesday has Durable Goods and Thursday GDP, Jobless Claims and the Help Wanted Index. Friday closes with Personal Income/Spending, Michigan Sentiment and PMI. This week is just a warm up for the first week of June and ISM, Productivity, Construction Spending, Factory Orders, Nonfarm Payrolls and Consumer Credit. The May data mystery will be solved over the next nine trading days and we will finally know if the war cloud has lifted.
Institutional investors and mutual funds are hoping for the best as the bullish scenario is spun over and over on stock TV. If you are hoping for the best then you don't wait until after the data to buy. You buy before the data and then be prepared to bail if it is wrong. If you are right then you could be up +10% over those funds that waited. If you are wrong you may not have lost anything if the market continues to rise into the reports. It is the perfect greater fool theory. John Doe fund manager is buying to beat Bill Smith fund manager to the punch. Bill Smith is buying to beat Bob Brown who is trying to beat John Doe. If the data is bad they all dump simultaneously and we get a crash. Everyone is hoping the very high 55% prewarning rate was excess caution and we will start getting more positive confessions than negative when the warning season for July starts soon.
As informed traders we are faced with trading our bias or trading the market. My bias has been biting me lately so I am going with the market. With the new highs running 14:1 over new lows the market is trying to tell us something. With the advances beating declines 2:1 on the NYSE on Friday despite only a seven point Dow gain there is a message. With the Russell-2000 posting its first six week gain in three years everyone should take note. The major indexes closed the week with a loss, a minor loss. Considering the drop last Monday this was still bullish. Whether this was another consolidation week or the first week in a repeat of 2002 we will not know until next Sunday. Remember that asset allocation shift I mentioned last week? It has not happened yet. Bonds are still soaring to new highs on the hopes for another Fed rate cut to combat the "D" word. Every piece of bad data and every mention of deflation spurs another round of bond buying. If we get a couple of positive reports next week and those bonds begin to fall the last ten paragraphs are immaterial. Once the trend breaks the rush could be strong.
I know I alienated many people today. There is a large contingent of traders constantly pointing out every potential chart pattern that could be even remotely suggesting a crash next week. I have to admit there are some good ones. I also have to admit we could easily test the bottom of that 8200-9000 trading range I suggested. We came close to 8400 this week but closed exactly in the middle at 8600 on Friday. There is no crystal ball and anything is possible. I look at those comparison charts for May/June and my gut reaction is look out below. On Friday the internals were telling us something else. Bear markets are built on the slippery slope of hope and bull markets climb over the wall of worry built by disbelieving bears. Just don't fight the trend. Follow the internals not the points.
Just to prove I have not lost my mind I will leave the bulls with the following NYSI chart updated from last week.
NYSE Summation Index Chart
The NYSI has stalled at the 1215 high from last Sunday, which is the highest (most overbought) since Feb-1999. The MACD has broken beneath the zero line and based on this chart alone I would be very bearish. However, remember the -200 point drop on Monday? It did not even cause a blip on the chart. Bullishness remained very high.
NYSE New Highs/Lows
Another reading of overbought conditions is the NYSE new high/low chart at +355. This level has only been reached three times in the last four years. VERY overbought.
My parting thought is that these extreme indicators are one more reason why the market should and may go down next week. They are also very strong reasons why the bears will be shorting every top and then buying back those shorts in disbelief if the markets continue up. Over the last five years we have seen some serious market extremes. Who is to say these overbought conditions cannot become even more extremely overbought? At 21.38 the VIX is in the danger zone but still well above its historical YEARLY low of 19 for each of the last three years. In 1998 it dropped into the 16s three times. Never say the market can't go any higher. It may not but then again we could be surprised. I looked at a lot of Dow stocks Friday night and there were very few I would buy. Just look at charts of IBM, MMM, WMT, GM, JNJ, CAT, GE, MRK, INTC, MSFT, DD and AA and you will see why the Dow closed flat on Friday. You will also see the reason why the bulls could have trouble next week. Big caps are under pressure while small caps were still moving up. There are mixed messages under every chart and behind ever indicator. Next week should definitely be interesting.
Enter Very Passively, Exit Very Aggressively!