Is That It?
After a +200 point gain the bears could only manage a -50 point sell off at the lows of the day and the markets finished in the green. This lack of shorting conviction at new highs for the year is proving that the bears have abandoned the fight and may be getting sleepy after several months without any rest. Don't start counting those Dow 10,000 chickens just yet. The race is only half over.
Dow Charts - 240/weekly
Nasdaq Chart - Daily
The bad news bulls were thrown an economic setback this morning when economic reports suggested that deflation was less a threat than previously thought. The Consumer Price Index came in flat instead of falling slightly as expected. After falling -0.3% in April the index surprised analysts with the recovery. Core inflation actually rose +0.3% but was offset by drops in energy. This one report has thrown Fed prediction theory into turmoil. This was the largest jump in core inflation in over a year. We thought the inflation monster was dead and his evil twin was about to appear in our midst. Surprise, surprise. Is this a reversal of the trend or just a blip on the down slope? Inquiring minds want to know.
Adding to the Fed's problem was the Industrial Production which also rose more than estimates at +0.1%. These numbers may not seem like much to the casual observer but it is the reversal of the trend that is causing raised eyebrows. The economy may actually be recovering instead of falling into the deflation quicksand. The final chapters have not yet been written as Capacity Utilization remained at a 20 year low. It appears the end of the war did provide a very slight bounce in the economy but the problem for the Fed is one of indecision. Is it a blip or a reversal?
The problem for traders is one of demand. Despite the better than expected CPI and IP/CU there has not been any pickup in demand. Manufacturers are ramping up (or ramped up) production in expectation of a new demand wave once the war was over. That demand wave has failed to appear anywhere but in the home market. Retail Sales came in at +0.3%, which reversed last week's losses but is still continuing the downward trend. Part of the lack of demand is still the rising unemployment which according to John Snow today could continue to rise to 6.2% to 6.3% before it gets better. Sales are stable but not improving, yet. All indications are the consumer will get one more round of refinance cash and that could power the next retail bounce.
John Snow said the employment picture remained bleak for the short term but he expected it to get better WHEN the economic recovery appeared. According to the Manpower Employment Outlook Survey released today the index fell to 11 for the 3Q compared to 13 for the 2Q. This means employers are expecting to hire less workers for the 3Q than they did in the 2Q. 50% of the employers surveyed said they would hire fewer workers for the seasonal 3Q production cycle than normal. Survey critics claim it was taken during the height of the war and SARS outbreak.
Despite the unemployment numbers the homebuilders are going for the gold. Housing Starts soared to an annual rate of 1.73 million and recovered entirely from the April drop. The obvious reason is the lowered interest rates and the assumption the Fed is going to cut rates again next week. That assumption took a serious hit today.
With the NY Empire Survey on Monday and the CPI/IP today the Fed's fears of deflation may be groundless. At least that is the short term theory that played out in the stock/bond markets today. The Fed fund futures WERE showing a 62% chance of a 50-point cut next week. After today's reports those odds fell to only a 38% chance. The balance of risk wavered for those expecting lower rates ahead. For the second consecutive day bonds sold off and yields rose sharply.
Ten Year Treasury Note Yields - 60 min
The markets are now faced with a problem. Traders have been looking for a 50 point cut based on the prior comments of Fed heads and the negative economics from several weeks ago. The economics appear to have turned and the Fed may only cut 25 points. Traders are now confused. Do they sell the decrease in potential for a rate cut or do they buy the potential for an improving economy. Wait a minute, they have been buying the potential for an economic improvement over the last three months. The news this week should have been confirmation of that hope. Do you buy the news or the rumor? If you have been buying the rumor all along then "normal" trader reaction is to sell the news. Confused?
It is only going to get worse. The constant tirade of "buy now" comments from the talking heads has turned to a "take some off the table" plea instead. Most traders did not follow their comments on the way up and it is doubtful they will have much impact on the flip side.
I think the next three weeks are going to be very volatile. For those that need more vivid word pictures that means we are in for some major swings and you know what happens in a swing. There are ups and downs. According to most knowledgeable analysts there are quite a few funds that are still under invested. They, like 47% of traders according to a CNBC poll, thought this bounce was just a bear market rally that would fail. Now they are faced with an end of quarter and end of half with cash on their books. Half of their year is already over and they are under performing their peers. It is time to spend that cash and dress up those statements with numerous commentators calling for Dow 9500-10,000 soon. It does not matter that those numbers may not be hit in June because it is the publics perception of the market that counts. Reality is irrelevant. According to another survey 35% of funds were overweight in techs despite thinking they were overvalued. 66% of fund managers think the market is overbought.
This is also a quadruple expiration week. Equity Options, Index Options, Index Futures and Single Stock Futures. Tack on a critical Fed meeting next Tuesday, the end of quarter and half and a market that has stretched overbought to multiple decade extremes and the fireworks are about to start. Add in a bleeding bond market at 45 year highs and the potential for excitement is off the scale.
According to Art Cashin tonight the professional traders are planning to be short come month end to capitalize on the remaining funds getting long for the quarter and then dumping in July. The professionals are expecting dips to be bought for the rest of the week as the remaining funds race to dress up their statements. Hedge funds that have been playing both sides of the market will be forced to cover shorts going into the month end for the same reason. Market makers who took the other side when traders bought puts over the last month had to short stocks to cover the puts they sold. Those positions will have to be squared and that stock bought back.
The volume today was very deceptive. All day long it appeared the volume was going to be very light but a surge in the last hour pushed it over four billion across all markets. Both the NYSE and Nasdaq came very close to two billion shares on a LIGHT day. The markets SHOULD have sold off today after the very strong Monday. They didn't. Bulls were unable to push the Dow over 9350 but bears were unable produce a loss. Every dip was bought in volume. In the Futures monitor we watch contract volume at strikes away from the current price and there was a large and constant bid just under the current range. If you look at the volume in individual issues it is clearly institutional. They are holding their nose and hoping for a dip to buy.
The only economic report of importance on Wednesday is the Monthly Mass Layoff report. This could see an upside surprise if the trend from the Challenger Report follows through. This would put more pressure on the Fed and the bond market and theoretically supply more cash for equities. I know, it does not make sense. I just told you the stock market was overvalued and due for a correction the first week of July and now I am saying bond junkies may sell and put the money in stocks. I did not say it would all happen tomorrow. The pivotal day is June-25th and the Fed announcement. Everything will revolve around that. Funds may want to hold off on buys until after the meeting in hopes of a market drop on the announcement. Conversely, they may want to buy now in hopes of a larger than expected cut. Between now and July 1st the markets will become more and more volatile as traders jockey for position. Everybody has a different agenda and a different calendar but all will reach critical mass by June-30th.
Compounding this problem was the Semiconductor Book-to-Bill report tonight which showed a drop in orders and shipments for May. This was the third consecutive monthly drop and could actually be good news for the bulls. It shows that the market has not recovered and is still weak and actually helps the case for another rate cut. It is simply a monstrous chess game. Every report can be looked at in several different ways by the bulls and the bears. Each move, however insignificant it seems, will eventually impact some other event later in the game. Institutional traders try to analyze the hundreds of events past, present and future to predict the next market move. The magnitude of possibilities will make your head spin but it happens every day. When you have billions at risk you have to analyze the potential outcomes for days and weeks ahead. Retail traders simply go with the flow like legions of pawns each striking their individual blow for the common cause.
For the next two weeks the magnitude of inflection points for the market are off the scale. We are grossly overbought and at new 52-week highs after posting massive gains from the Oct/Mar lows. We are entering the July earnings season where 824 companies (as of Monday) have already issued guidance. 422 of those companies have warned compared to 211 that raised estimates. Anything is possible. Did those 422 over warn due to the war, SARS and Sarbanes Oxley? Will they surprise to the upside instead? Will the Fed bluff its hand and stand pat with no change on improving economics or go for broke and shoot the works with a 50 point cut? Will the warning season pass uneventful and thereby give the bulls more confidence to buy the top? Nobody knows but while you are reading this there are computers somewhere analyzing all these possibilities.
My suggestions are to tread softly for the next three weeks. We could go either way very fast depending on the news events and the results of those computer runs. To compound the comments above, the first week of July is typically the strongest week of the month. The first week of the 3Q and 2H sees an influx of retirement money that could overshadow the negativity from the overbought conditions. According to the Traders Almanac the first trading day of July has been up 12 of the last 13 years. That is a trend that few will want to fight and many will want to capitalize on. The 1st is on a Tuesday with Friday the July-4th holiday. This means many traders will want to be in/out of their positions on Friday June-27th and take a long holiday until July-7th. Now that I have you really confused about what to do just imagine you had several billion dollars at stake based on your trading plan for the next three weeks. Fund managers everywhere are facing that decision this week. Those who gambled in March are sitting on fat profits and well ahead of their competition. Do they hold or fold? My bet is a close for a fast buck once July arrives. Definitely not all their positions but those with the greatest profit at risk. With conditions heating up in Syria, Jordan, Iran, Israel and Iraq there is always the potential for a catastrophic event. Taking some chips off the table is only prudent.
As a commentator and spectator this is the kind of setup that really excites me. I love to watch the cards as they are dealt and watch how the big money plays the game. I could easily see 9500 this week and even higher numbers ahead if all the cards fell correctly. However, anyone that has ever played poker or any other game of chance realizes how seldom the cards fall correctly. That brings us back to the volatility comment. This is normally a very slow period in the markets but this is far from a normal market. About the only thing we can say for sure is the next three weeks will involve high volume and high volatility. Be careful, there may be fireworks that are not on the 4th.
Enter Very Passively, Exit Very Aggressively!