The markets rallied off strong support on Friday on mixed economic news and news about Hussein from Iraq. A general reportedly said they were getting closer to catching Saddam after a group of his aides and body guards were captured on Friday. With this highly volatile market and a definitely bullish undertone I am sure more than a few bears realized the extreme weekend risk and covered their shorts. Bulls happy about the better than expected Durable Goods report saw the market bounce off strong support and they jumped on for the ride. The result was the third strongly bullish Friday in a row.
The economic reports continued to show a glimmer of hope for those squinting to see a recovery ahead. The Durable Goods rose by a better than expected +2.1% pace and better than the expected +1.5% consensus. Nondefense capital good rose for the second month in a row. The only really negative component was communications equipment which fell by -9.6% and increased its rate of drop for the fifth consecutive month. Computers posted the smallest gain at +0.8% and Aircraft/Autos rose the most at +4.2%. Shipments and unfilled orders both rose as well.
Also showing positive momentum was the Weekly ECRI Leading Index which rose to 127.4 from 126.8. This was the best level in three years. It made these gains on only two components, Jobless Claims and 10-year Treasury Yields, with minor declines in most of the other components. This shows the economy is poised to expand and the ground work has been laid. It is not however showing an expanding economy. The mediocre internals are struggling to make the gains but still creeping to new highs. The recovery is in progress but at a snails pace.
New Home Sales jumped +4.7% to 1.16 million units and +21% higher than the same period last year. However May was revised down to 1,108 from 1,157 and April was revised down to 999 from 1,028. These were significant downward revisions but as long as the June number holds at 1,160 nobody will care. The problem will come if June is revised down next month. The higher mortgage rates will pressure home sales going forward and it will be difficult for future numbers to match these levels. After several years of record sales the demand for new homes is beginning to slow. As the baby boomers begin to retire over the next few years there will be a surplus of used homes to pressure the market.
Existing Home Sales fell unexpectedly to 5.83 million from 5.85 million in May and was much less than the 5.97 million that was expected. Sales in the Northeast fell by -4% and the Midwest by -3% and increased +3% in the West. Inventory levels soared to levels +10.6% higher than the same period last year. More for sale signs are appearing just as mortgage rates are beginning to soar.
AOL was under pressure on Friday after disclosing that it had padded the subscriber numbers in 2001-2002 by giving away subscriptions to marketing partners for $1 to $3 each. The very discounted subscriptions accounted to about 15% of their subscriber base during that growth period. Essentially they sold these highly discounted subscriptions in bulk to employers and marketing partners which those companies then gave to employees. This distorted the true value of the subscription base when analysts multiplied average revenue by gross subscriber numbers. AOL said they lost -846,000 subscribers in the second quarter and they were continuing to clean up the subscriber lists and eliminate nonpaying customers. AOL called it a nonevent but they did warn that revenues would be light for the current quarter due to the falling subscribers and weak advertisement revenue.
Richmond Fed President Alfred Broaddus spoke on Friday and said he was disappointed in the lack of economic progress. He said "there were a few signs that the recovery may be gaining strength but in my view there is not much hard evidence that it is happening yet." He also said "it was too soon to conclude from recent hopeful indicators that a faster-paced expansion had taken hold." We will get look at the GDP for the 2Q next week and most analysts think we will be lucky to see a +1.7% gain after the +1.4% gain in the 1Q. With the country gearing up for the war most feel the first half of the quarter was flat to down. This will be a hindsight number and should not be a market mover unless it is significantly less. Still it is one more mile marker for the current economic progress.
The Wendover-Global Insight IT Spending Index, an independent survey of 80,000 businesses and 300,000 individuals, showed that tech spending fell -14% in the second quarter. It predicts lower IT spending for the balance of the year. The Q2 spending levels were the lowest since the index was started in 1999. This was also the first time the index had been released to the public. While most smaller surveys predict spending will be flat to +6% for the rest of the year the Wendover Index shows declining spending sentiment. The index fell -6.2 points to 37.6 in the latest survey. The high was 115.4 in Q2-2000. They did show a slight increase in spending in the CRM and ERP markets. They also showed a sharp drop of -45% in new tech initiatives. They said they were seeing a trickle of new spending budgeted over the next 6-9 months but far from the flood that had been hoped. They said businesses are waiting for significant signs that the economy is recovering before planning on committing any new funds to IT projects. The survey showed that companies are still concentrating on cutting costs to maintain profitability and much of those costs were in capex spending. 40% of all capital expenditures are on IT projects. With businesses accounting for two thirds of all U.S. tech spending there will not be a tech recovery until the economic recovery is well underway.
The stock market was rocked on Friday morning by what was called an asset allocation program where stocks were being sold and bonds bought. This clearly shocked many traders as this would be a very bearish signal. Just when bonds are reaching three month lows and economic reports are starting to show a glimmer of hope you would not expect a huge shift of assets out of stocks. Those stocks should benefit from an improving economy and bonds should continue to go down. That poses a question why a major player would drastically change directions. The Dow dropped nearly -100 points on the sell program before triggering a series of offsetting buy programs when the S&P futures hit the 50 DMA at 975.
There are some very mixed views about the current market. After Friday's bounce, the third bounce for the week, the bulls are frothing at the mouth. They are pointing at the 161 companies that have either initiated or raised dividends over the last six months as positive proof that the economy and the market is improving. There were only 110 positive dividend events in all of last year. The average increase is +18%. They are also pointing to the +15% growth in S&P earnings so far this quarter as better than the expected +14% growth. With 65% of the S&P already reported, the better companies report early, it is still likely we could see 14% or even worse. Remember, the majority of these earnings have come from cost cutting not from sales. What the bulls do not want to acknowledge is the 2:1 ratio of negative guidance to positive guidance for Q3. During the Q2 earnings cycle in 2002 the ratio was only 1.3:1 for the same period. With drastically lowered expectations for Q3 already the warning pace is drastically worse than Q2-2002. What is wrong with this picture?
After watching the markets alternate triple digit days this week I have to admit I am about ready to concede. We have had multiple chances to fail and have tested the critical support on the S&P five times in the last seven trading days. Each day it held and on more than one occasion soared to very near a Dow high. This is very bullish trading for the third week of July. This is not the normal July pattern. I am seeing bullish events breaking out all around me in a typically bearish period. This is not to say we are not seeing some bearish events as well. The bearish sentiment as recorded by Investor Intelligence is extremely low at 19.8. This is also reflected in the VIX which finally closed under 20 and the first close under that level since March-28th of 2002. This was also the last time the Dow touched 10,500. Coincidence?
Like I said earlier, I am about ready to concede. That should mean there is a capitulation due any day. When all the indicators line up in one direction a change in that direction can come at any moment. The close on Friday was very bullish but what caused it? I think it is the Lazarus syndrome. Saddam has been off the radar screen for a couple months. When the U.S. removed his top two biological weapons last week the markets exploded. At least they exploded for one day. Bears have a decent short term memory. They remember getting killed by the resurrection of the Hussein name only two days ago. When a general said on Friday that the noose was closing on Saddam they listened. When more of his aides and bodyguards were captured on Friday on tips from Iraqi citizens they listened. They weighed the potential for risk over the weekend and decided there was more potential for upside than downside. They weighed the Durable Goods numbers and the ECRI and the New Home Sales and decided the risk reward ratio was not favorable for shorts.
Bulls on the other hand were seeing money come out of bonds and yields rising which normally means economic growth on the way. They kept hearing the spin about the better than expected earnings and Ralph Acompora's Dow 10,500 forecast. Dollar signs blinded their reasoning and they bought stocks before they ran away from them. They heard the rumors about Saddam and thought if we can get +150 on his sons we can get +300 on the father. They bought stocks. Do you remember the market during the war? The rumors, the UN meetings and the showdown at the UN corral? The market jumped all over the place for no rhyme or reason. Well this has definitely brought back memories of that time. The volatility has been huge but the VIX closed at a new low. What do you suppose will happen if Saddam is not found over the weekend? Once reader theorized we could add +1000 points over the next couple weeks if we could get a new Saddam capture rumor every day next week. When does he become priced into the market?
I am not going to tell you today that the Dow is going to 8500. If this hype continues we could see 9500 before 8500. I am going to tell you that 9300 is serious resistance. I am going to tell you that S&P 1015 is huge resistance. Neither are unbreakable. You might also notice that the S&P closed at 998, just under the 1000 barrier with the Dow already at 9275. The Dow is 35 points away from its high and the S&P is 17 points below its high. The broader market is not keeping up with the Dow. The Nasdaq is -46 points from its high, farther than the Dow. All of these things can change and we could be on the verge of a massive bullish breakout. Stranger things have happened before.
Next week is going to be more dangerous than a casual stroll though Monrovia, Liberia. It will be equally dangerous to both bulls and bears. Monday will be neutral with no economic reports scheduled but the calendar heats up fast. Tuesday has July Consumer Confidence but that should not be a market mover. Wednesday has the Fed Beige Book. The fireworks start on Thursday with Jobless Claims, adjusted?, Employment Cost Index, GDP, PMI and the Help Wanted Index. Friday has Personal Income/Spending, Nonfarm Payrolls, ISM, Michigan Sentiment and Construction Spending. Whew! I would not want to be a market maker going into Friday.
These reports will be dangerous to both sides because they will reflect the economic conditions for the first month of the 3Q. As July goes, so goes the quarter. If they are seen to be weakening then the party may be over. If they are seen to be getting stronger then break out the champagne.
Remember what happened to EBAY on Friday? They lost $6 at the open after record earnings because the market wanted more. It wanted something to justify the huge gains over the last several months. Well at 9300 the Dow is priced to perfection. MMM jumped from $126 to $141 last week on strong earnings. That is a huge gain and a new 52 week high. CAT jumped to $65 from $58 and a new 52 week high but stalled. DD jumped +10% and is near a new high. INTC soared to over $25 after earnings and a new high but stalled to close at 24.91 for the week. AA +10% and at new high. These leaders are very extended and carrying a lot of baggage. Consider the charts for MO, IBM, GM, WMT, JNJ, MRK, HD, BA, HPQ and SBC. How much farther can the leaders run with a third of the index on their back?
Before you decide I am a perma bear I would like to restate my
position. I am bullish on the market long term. I think the cost
cutting and restructuring will be very beneficial when the future
recovery appears, hopefully in the fourth quarter. While I have
been anticipating a dip at the end of July it was only because
a historical period of consolidation and profit taking normally
occurs at this time each year. If I look at the charts with a
bullish bias I could paint a bullish case despite the calendar.
Wilshire-5000 Bullish Chart
Using the Wilshire-5000, the broadest market indicator of all, we can avoid material spikes from $15 moves in MMM and see what the real market is doing. We had a bounce in the $TMW.x from 7503 in March to 9692 in June with very few pauses for profit taking. That is a +29% gain in four months. This is highly abnormal. At the top of that gain we dropped back -400 points and held on 9300 for two weeks. Then we made another try at the highs and have pulled back again for two weeks but at a higher low around 9400. This sideways consolidation is bullish. We have held the majority of the gains and are slowly inching higher. A bearish view would say a lower high on this current attempt will signal doom for the bulls and they could be right. They are not right until the index falls below 9300, which is very strong support and it will have to break the 50 DMA at 9379 first. 9300 on the Wilshire happens to equate to 9000 on the Dow.
Dow Chart Bullish View
The Dow chart looks very similar to the W5K chart in that it is clearly showing a nice consolidation pattern between 9000-9300 and higher lows since July 1st. The resistance at 9300 is strong but you can see the upward pressure building.
Depending on whether your glass if half full or half empty you could also paint a bearish case from these charts. Using the Nasdaq below you can see for the last two weeks it has been trending down. Down in an uptrend channel but down. The real test is about to occur if it can break that declining resistance line around 1740. You can see the resistance/support points narrowing and something is going to break soon. With the uptrend line now at 1700 the importance of holding that level is becoming stronger.
Nasdaq Chart Bearish View
Dow Chart - Bearish view
The Dow bearish view anticipates a double top failure at 9300 and a failed retest of Dow 9000. Granted that is a lot to swallow today but that is the bearish view.
The problem all along has not been the case for investing in stocks. I have been saying for months that when bonds crashed billions of dollars would find its way into the stock market. Well boys and girls bonds crashed. They gave up nearly 2.5 years of gains in the ten year and 3.5 years of gains in the 30 year. This takes into account the price of the bonds and the yields. The ten-year yield at 4.2% is very near a 12 month high. This all happened since the June-25th Fed meeting. This bond disaster will hit home when the monthly statements come in about a week and the bond buyers thinking they are in a safe investment will get a serious shock. Stocks will start looking a lot better very soon if we get one more leg down in bonds. I actually think bonds will improve over the next two weeks. Why? Because there is a FOMC meeting on Aug-12th. While the Fed Funds futures are showing a zero chance of a rate cut there has been some noises out of a couple Fed heads last week that things are not rosy. Bernanke said deflation was still a substantial risk and could increase even with a pickup in the economy. Broaddus said he was not convinced a recovery had started. The biggest reason of all is to shock bonds. If Greenspan popped another surprise 25 point cut out at the Aug-12th meeting the bond market would go crazy. They would start worrying like there was no tomorrow and rates would plummet. The housing market would get back on track and we would be back in the grove. Idle speculation on my part but then it would solve a major problem for Greenspan.
That brings us back to the original July decline premise. It is historical and very dependable. However you don't normally get a multiyear bond meltdown in July. This was a catastrophic event in the bond market that has shaken the normal July calendar. Add in some glimmers of hope in the economic reports and we could be off to the races. Except for a couple of points. Obviously from the multiple attempts to break support last week there are quite a few people who are not convinced the recovery is in progress. Whether you admit it or not there was some heavy selling several times. Also, remember those fat finger trades that were determined to be real trades once the smoke cleared? Not everybody is on the Sugarland express and expecting to be popping champagne with Acompora at the 10,500 party anytime soon.
Yes, I am almost ready to concede the July dip has been cancelled due to lack of interest and a bond catastrophe that will be talked about for years. Almost. I still have that nagging thought in the back of my mind that if Saddam is still in hiding on Monday the outlook could change quickly. If they catch him over the weekend then Dow 9300 is history and the entire conversation will begin again at a higher level. There are no guarantees for anyone and least of all traders. Just when you think you have everything figured out something changes. That is what keeps it exciting.
Enter Very Passively, Exit Very Aggressively!