Bears In Trouble
Good news is breaking out all over. That may not be entirely true but if you were a bear on Friday you probably felt that was the case. Even the bad news was minimal and the spin-doctors were doing a great job turning it bullish. What is a bear to do now?
Dow Chart - Daily
Nasdaq Chart - Daily
S&P Chart - Daily
After a banner week the hopes for a bearish summer may have dimmed but they are a long way from extinguished. Bulls cheered the news on the economic front and analysts were jumping at the chance to predict good things for the second half of the year. While the bad news bulls have been successful in powering the market to new highs for the year will an over abundance of good news prove to be a lethal overdose of an otherwise good thing?
Friday did not get off to an early start after the Personal Income report showed a marked decrease in the recent upward trend. The April report showed that income was flat compared to the consensus for a small increase. This was the first time in eight months that income did not increase. The report showed that they were not spending what they were not making with spending dropping -0.1% and down significantly from the +0.8% in March. The key was the impact of the weak labor market and drop in hours worked. With employment continuing to fall the odds are good this number will continue to shrink. One offset to the drop in spending was the drop in energy prices. We can all agree to spend less if gasoline continues to fall and I doubt the economy will suffer. The 25 million checks now being prepared as a result of this weeks tax cut plan will help boost the spending over the next several months.
Despite the drop in income and spending the Michigan Sentiment held firm at 92.1 for May and only dropped -1.1 points from the initial reading two weeks ago. This was up significantly from April's 86.0 reading and did not show any deterioration from the lingering affects of the war. There was a +12.1 point increase in the expectations component which overcame a drop in the current conditions to 93.2 from 96.4. It shows the belief in the second half is still alive and well despite concerns about current unemployment. The confidence numbers could be fragile in the June report as there has been a growing concern over the last week that employment is worsening. With three separate negative employment reports last Thursday there is a strong possibility the nonfarm payrolls next Friday will also be negative. Part of the sentiment increase was the expectation of the tax cut. That is now priced into the market.
The biggest positive for the day and possibly for the month was the jump in the PMI number to 52.2 in May from 47.6 in April. This was a huge spike and well over consensus at 49.0. There was a strong bounce in production to 60.5 from 51.0 and new orders to 54.6 from 44.6 in April. These are huge gains and they offset a small decrease in order backlog of -1.4 points. The production and new orders components are at their highest levels since February. This jump in the Midwest economy bodes well for the national ISM report due out on Monday. The ISM is the key economic report next week and the good news from the PMI helped to close the markets at the highs for the year. Expectations for continued good news are running very high.
Not all the Friday reports contained good news. While the PMI showed bullish conditions rising in the Midwest the New York NAPM report showed continued declines in the northeast. The NAPM fell to 229.6 in May from 234.5 in April and marked the fourth consecutive monthly decline. The six-month expectations component rose from 56.3 to 61.1 but current sentiment is negative. One of the problems in the northeast is the rapid rise of local taxes as state and local governments try to offset the impact of the economic decline. Unemployment in New York is still falling but the rate of decline is slowing. The NY-NAPM was seen as problematic to New York and the excesses of the area along with lingering impact from 9/11.
The Nasdaq closed at 1595.91 and the highest close since May-31st of 2002. Coincidence? This is a remarkable feat especially when you realize it has been done on the back of the chip stocks and the chip sector is not especially healthy. The semiconductor billings for April were flat compared to March at $12.14 billion and below expectations. Chip sales rose in Japan and Asia but fell in Europe and the Americas. According to an industry spokesperson the estimate miss was due to a slowdown in demand for the final products including cell phones and computers. The forecast for chip sales for the rest of 2003 is still declining despite BEA data showing a +2.6% increase in IT spending in the forecast. SIA reported that inventories are trending downward as capacity increases for new technology which will ultimately lead to more profits when the recovery does appear.
In the midst of the wildly positive PMI and the mildly negative Income/Spending and the ignored NY-NAPM the markets roared off to new highs for the year. This rally is being fed by a new influx of retail cash according to US Bancorp Pipper Jaffray. They claim +$2.8 billion in new cash flowed into the markets over the last week as well as $16.8 billion coming out of money market funds. That cash powered the Dow to a +250 point gain and the Nasdaq to +85. Even more impressive to market technicians was the +22 point gain on the Russell-2000. The percentage of RUT/COMPX gains was the same at +5.5% but the Russell gain is actually more important. The small caps lead out of bear markets and they have definitely been leading. The Russell has posted a +98 point gain since March and 22% of that gain came this week. Clearly not only are funds spending some of their hoarded cash but retail investors are also stepping up to the table to place their bets.
Volume has been soaring with the Nasdaq posting the highest volume day of the year on Thursday. 4.75 billion shares traded hands across all markets on Thursday and 4.5 billion on Friday. Up volume beat down by about 3:1 on Friday with a 12 month record of 831 new 52-week highs compared to only 21 new lows. The bullish factors are almost off the scale not only in the overbought indicators but in investor sentiment. The summation index below is literally off the chart and showing full bearish divergence.
NYSE Summation Index Chart - Daily
While this is causing the bears to toss in their sleep it is giving the bulls cause to celebrate. The overbought conditions are simply one more big brick in the current wall of worry the bulls are scaling. Deflation fears seem to have evaporated and the risk of recession is now only 9.7%, down from 35.1% in Oct according to the Economy.com report released on Friday. Those concerns are simply disappearing if you believe the PMI and the May rally. SARS, terrorism and the jobless recovery appear to be no match to the markets desire to shake off three years of a bear market and forge ahead. The Dow has been positive for three consecutive months, the Nasdaq four and that has not happened since 1999. Does all this bullishness worry anybody?
The markets are priced to perfection and are currently assuming a blockbuster second half with 4%-5% growth rates. The only hurdles ahead are the ISM report on Monday and the Jobs report on Friday. If you believe the analysts those will be positive or at lease show significant improvements. Needless to say all these expectations are priced into the current rally. You will notice from the chart below, which compares the S&P with historic PE values we are actually beginning to increase the gap not close it.
The markets have priced in a roaring recovery and the Dows +250 point gain this week has accelerated that pricing. The bulls are obviously looking for more positive data and they will get that chance next week. Monday has the ISM and Construction Spending. Tuesday BTM, Wednesday Productivity, ISM Services, Thursday Jobless Claims and Factory Orders. Friday we get the Nonfarm payrolls and Consumer Credit. Easily the two most critical are the ISM and the Payroll report. If the ISM follows the PMI then the bulls have a good chance of breaking the current market top. That will give them a week to worry about profit taking before a negative jobs report. Once past that hurdle the economics will take a back seat to the coming earnings warning season which starts the second week in June. With "only" 54% of the S&P companies already warned for the 2Q that leaves plenty more to confess. The bullish view has many of those that already warned coming back with a positive upgrade due to less war impact than previously thought.
The market has some technical hurdles to overcome as well. On the earlier S&P chart you can see that it closed at a very bullish 965 and exactly at the intraday high from last August. This is a very critical level but that level could be easily broken on short covering if the ISM produces a positive surprise at 10:AM on Monday. The Dow is facing the same problem at 8850. This is strong resistance from January and it failed to hold over 8850 three times last week but closed magically right at 8850.26 on Friday. So close to real confirmation and again that confirmation could come at Monday's open. The Nasdaq is the most extremely overbought with a bullish percent at 84% but it is also the most likely to continue the run. It is currently just below 1600 but once over that psychological hurdle the next real resistance is a long way off at 1750-1800. If you note the Nasdaq chart above you will see it broke through the uptrend resistance in place since February. With the BP at 84% and very extended I would be very surprised if we did not see a pullback to the support line soon. It has gone +100 points in only five days and that equals the rebound gains on the March spike. It pulled back then as well. A slight bout of profit taking next week could then set the stage for a continued run. Overall the bulls are giddy with excitement as they charge over the bears.
Considering there is a major bullish factor still to come into play they may have reason to be excited. Despite the major market gains this week the bonds closed almost exactly where they closed last week. Yields are still near 45-year lows and there were only a couple of minor selling spurts during the week. The asset allocation event has yet to occur. Buckle your seatbelts. There was a news story on Thursday that the State of Illinois was waiting for the ISM on Monday to shift $4-$6 billion from bonds to stocks. Several other states were also mentioned as potential targets for asset allocation next week as well. The ISM was 45.4 in April and fell for the fourth consecutive month. The estimate for Monday is 47.2. If the ISM is positive or simply beats the 47.2 consensus estimate I think we could see that allocation event begin. If the economy is apparently back on track and recovering then the odds of a Fed rate cut on June-25th become much slimmer. The risk of being in bonds instead of stocks becomes increasingly higher.
I suggested last Sunday that we follow the internals not the indexes. They were strongly positive and indicating that every dip was being bought in volume. This week accelerated that trend. The internals and the volume were much stronger despite several attempts to sell off. The nearly -200 point drop from the intraday highs on Thursday was bought strongly and we closed right back at the highs for the week. The constant stream of bearish emails has dwindled and even some diehards are starting to go long. This alone should be a sign we are near a top. My outlook for the week is very mixed and mostly dependent on Monday's ISM report. If it is bullish then we should breakout. If bearish it may be hard for the bulls to maintain the momentum at these extremely overbought levels without the support of cash coming out of the bond market. The bottom line is trade the trend and buy the dips until the trend changes. The first two days of June are historically bullish but the ISM will control that next week. After June 3rd the odds get worse on a historical basis as June is not known for gains. Could be just one more brick in that wall of worry and after the non typical May it is clear the bulls are not watching the calendar.
Enter Very Passively, Exit Very Aggressively!