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Market Wrap

Bond Blues Back

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      07-15-2003           High     Low     Volume Advance/Decline
DJIA     9128.97 - 48.20  9238.01  9091.30 1.91 bln   1048/2182
NASDAQ   1753.21 -  1.60  1777.78  1742.10 1.87 bln   1413/1793
S&P 100   504.07 -  1.12   508.56   501.82   Totals   2451/3975
S&P 500  1000.42 -  3.44  1009.61   996.67 
W5000    9640.98 - 35.60  9727.87  9605.24
RUS 2000  475.93 -  2.10   480.85   474.47 
DJ TRANS 2573.97 +  1.10  2596.86  2565.46   
VIX        21.84 +  0.43    22.34    21.30   
VXN        33.95 +  0.06    34.59    32.81 
Total Volume 4,018M
Total UpVol  1,430M
Total DnVol  2,407M
52wk Highs  744
52wk Lows    22
TRIN       0.87
PUT/CALL   0.54

Bond Blues Back
By Jim Brown
Click here to email Jim

It is not nice to tease the bond junkies especially when they are holding the fate of the economy in their hands. Greenspan talked a big bluff and said all the right things but his words fell on deaf ears. The bond bulls ran for cover despite threats of lower rates ahead.

Dow Chart - Daily

Nasdaq Chart - Daily

Economic reports were good but traders did not applaud. The weekly Chain Store Sales rocketed +0.9% for the week ended July 12th and produced the largest back to back weekly gains since April. Summer weather and steep discounting reportedly produced the gains. Stores saw increased traffic as rains dried up in the eastern part of the country.

The Monthly Retail Sales jumped +0.5% and was inline with estimates despite a dip in auto sales. Some employers have already started reducing tax deductions for workers and that money is finding its way into the stores. While that may be the case on a very limited basis the far more likely reason was the current weather and the massive discounting to blow out Easter, Mothers Day and Fathers Day goods that were not sold due to bad weather then.

The NY Empire State Manufacturing Survey posted the third monthly consecutive gain and was strongly positive at 22.6. That was the official spin on the headline number. That headline number actually fell from 27.6 in June and inventories, back orders, delivery times, prices received and employment all dropped into negative territory. Unfilled order backlog fell to -5.7 from +2.6. Delivery fell to -6.4 from +3.1. Employment fell to -8.6 from zero. Prices received, you know that "unwelcomed decrease in inflation" fell to -14 as pricing power continues to erode. The six-month outlook began to erode as well with a drop to 52.5 from 58.9. I am not saying this was a negative report but it was not as positive as the talking heads tried to spin it.

The biggest economic news for the day was not a report but a speech by Greenspan to Congress. The event was not without controversy and a major amount of grandstanding. Greenspan touted the numerous ways he felt the economy was poised to recover and the panel pointed out the numerous things he had done wrong and why the plan would fail. It was not your regular "praise meeting" full of "we have the utmost respect for you" comments. Panel members continually pounded him with verbal assaults so severe that other members publicly apologized for their behavior. Yes, it is an election year and Alan was forced to be the fall guy for the reelection crowd.

Alan said the FOMC was prepared to make substantial additional rate cuts to keep the economy on track and to use other weapons at their disposal for a long time to come. Unfortunately nobody believed him. With the Fed funds rate at 1.00% he admitted that any additional rate cuts could hurt interest rate sensitive businesses like money market funds as well as destroy retirement investments for millions of people who depend on CDs and short term interest bearing accounts for income. Alan did not win any friends there and the bond junkies laughed behind his back at what they considered an obvious bluff.

He also shot himself in the foot on the threat to use other weapons after he closed the speech with "However, given the now highly stimulative stance of monetary and fiscal policy and well-anchored inflation expectations, the Committee concluded that economic fundamentals are such that situations requiring special policy actions are most unlikely to arise." If the situation is most unlikely to arise then the bond market promptly ignored it and rushed to sell their bonds. The Ten year sold off a full two points and the 30-year a full three points. Yields on the 30-year nearly hit 5% and the ten year hit 3.968%. The interest sensitive stocks got killed with home builders selling off substantially along with utilities. It was a rout as bonds hit three-month lows and gave no indications that anything was going to change. Suddenly the Fed's carefully crafted plan to keep interest rates low simply disintegrated before their eyes. With refinancing applications falling -22% last week and rates soaring this week there could be an even bigger drop off ahead. The refi consumer as the pillar of the recovering economy has died. It is now time for the business community to step up to the table or the winter may begin early.

Adding to the concern was the newly released budget numbers showing the deficit for 2003 to be -$455 billion and 2004 to be -$475 billion. Oh, did you know that the 2004 numbers do not include any spending for Iraq? Considering it is currently costing $4 billion a month and the best estimates are for another 2-3 years then we could easily add $50 billion to every estimate for years. That puts us well over $500 billion for 2004 without trying. Greenspan was asked if we could tax cut ourselves back into prosperity and I do not need to tell you the answer. Long-term investors are very worried that this massive debt load coupled with a sputtering economy could combine to squelch the recovery before it starts. (just reporting here, not expressing an opinion) If the economy was firing on all cylinders then deficit spending would add to the fuel and power the rocket. The bottom line was bond junkies running for cover and selling bonds with both hands.

This is normally good for the market if that cash is headed for equities but there was no cash flowing in that direction today. The problem it appears is the carry trade. That means hedge funds, mutual funds, large corporate borrowers, etc, borrow short term money from various sources like Japan where interest rates are near zero and buying long term bonds in the U.S. That works well as long as bonds are going up or are stable but with bonds falling through the floor those trades have to be unwound quickly. The key level according to the bond junkies is a 4.0% yield on the ten year. Should that level be broken the amount of debt that would begin to unwind could be over a trillion dollars. This massive fund shift could cause ever escalating rates to the point where they spiral out of control and begin to feed on themselves. What a wonderful web of interrelated dependencies we feed on.

The point here is the Fed has lost control and they are at the mercy of the markets. They really do not have any bullets left in their gun and the bluff is not working. Greenspan will have an opportunity to try and improve his delivery and restate his case when he repeats his testimony to the Senate. Don't look for any new facts to appear but the delivery should be drastically different. He will have seen the bond drop today and be trying to grasp at any straw to recover control. Going to be an uphill task.

The earnings week is in full swing with over 25% of the S&P announcing earnings this week. The companies already announced have run the gamut of massive charges from companies like Boeing, massive losses from derivatives like FNM and massive warnings like Lucent but what else is new. Add in the funny numbers like the ETN gains from tax rate changes and just plain earnings misses from companies like RMBS. It is not your normal earnings season but after the bell today we saw the first major tech try to steal some positive headlines.

INTC beat the street by a penny and edged slightly past revenue estimates. They raised their gross margin estimates for the remainder of the year due to product mix and the slow demise of the AMD competition. BUT, after a rocket ramp in the futures after the announcement, Andy Bryant, the Intel spin doctor appeared on CNBC and said it was not a recovery yet. He said it was more like a return to normalcy where the tech improvements over the last two years were starting to pay off in profits. Intel stock paused for a few moments and then soared ahead as shorts raced to cover. The futures however rolled over immediately and have been drifting down ever since. Remember the good news from YHOO and JNPR were met with selling as the good news was already priced in. The Intel news may have surprised those that were expecting a normal 2Q miss as has occurred in the past and that lack of a miss is powering the INTC stock.

Also hurting the after hours trading were misses or warnings from LU, TER, SCHL, PHTN, ELON, IKON, CDN, PVSW and Motorola. Several companies met or slightly beat estimates and guided inline with estimates. Inline will get you nothing in a market that is priced to perfection. If you cannot guide higher and beat then you are toast. Wait, YHOO and JNPR beat and guided higher and they were still clobbered. Get the point?

Besides an instant replay of Greenspan on Wednesday we will get the CPI, Business Inventories, Industrial Production, Housing Index and Mortgage Survey. All the majors will be out before the market opens and should provide plenty of economic fodder for the bond bulls to chew on instead of Greenspan. The big gun for tomorrow is IBM after the close. That could be one more nail in the coffin if they do not blow the doors off their estimates. Offsetting the INTC gains in the Dow will be weakness in Citigroup after they announced at the close a $6 billion buy of Sears troubled credit card division. C was trading down after hours. Also, MO is still under pressure after an Illinois court said the previous court was in error when it changed the bond requirement.

The markets are poised to run but the direction is unclear. It was announced today that the recent "fat finger" trades in the Dow and S&P futures were real trades and were not errors after all. This is a sobering thought. The volume of trades required to push the Dow futures to near 8600 last week and the S&P to 990 on Monday are huge. These are normally dealt out in small doses and the multiple large sell orders hitting the market all at once have scared many traders out of taking long positions. This undercurrent of uncertainty right at the time that the market normally peaks in July is giving added influence to the dance with the Fed.

I have talked about it for several weeks now and the time is at hand. This is the week that would typically see the July peak and the beginning of the July slide. Once IBM, MSFT and the other 25% of the S&P companies announce this week the earnings outcome for all companies will be known. There will be no reason to wait around for the next surprise because there will be no more surprises. Sure some will beat and some will miss but historically the majority of the good earnings come this week from the giant blue chips. That leaves the rest of the pack bringing up the rear.

If you are watching a marathon with tens of thousands of runners once the leaders cross the finish line the excitement fades. You may still have a friend that you are waiting for buried deep in the pack but the rest of the faces become a blur once the leaders break the tape and draw the crowd of reporters. All attention will be on INTC, IBM and MSFT and then bonds and then the second half economy. If the bulls are going to pull a July rally out of their hat then this is the week to do it. If they can't do it this week then it is all over but the shouting. The next ramp job typically begins in August and that gives traders a couple weeks or more to shuffle portfolios based on the July results and guidance for the remainder of the year. Did I mention this is option expiration week as well?

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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