Close, Very Close
The markets ignored positive economic data and plunged to end very close to major support levels. Bonds fell and yields rose after a lackluster treasury auction and there are two more days of auctions to come. Cisco disappoints after the close and warns that while business is not getting worse it is also not getting any better. Are we having fun yet?
The morning started out well with Chain Store Sales rebounding from last weeks drop by +0.8%. Tax rebate checks are making it to the stores and six southern states had tax holidays to boost spending. The results were excellent and with school starting early the shoppers were out in force. Considering average selling prices have dropped -4% due to heavy discounting this means sales were actually heavier than reported. Inventory is being pushed out the doors and retailers are starting to breathe easier.
Also beating estimates by a mile was the ISM Services Index which soared to 65.1 when estimates were only 58. This was the highest level since the index began and the biggest jump in six years. This represents a 10-point increase in just two months. New orders jumped to 66.9 from 57.5 but prices fell to 50.6 from 51.4 and employment barely budged to 50.7 from 50.3. The services numbers are not normally market movers due to the manufacturing ISM, which comes out a week earlier. The numbers today were no different. We had a spike on the report but that spike was quickly sold and we ended much lower.
The only negative report of the day came from the Challenger Layoff report, which saw a spike in announced layoffs for July to 85,117 from 59,720 in June. The two-month decline ended with a steep jump. The continued need to cut costs to preserve earnings and higher productivity is taking its toll. However, the current level for all 2003 is 12% less than the same level at this point in 2002. Analysts tried to spin it as positive by pointing to the much higher levels earlier in the year when layoffs averaged over 100,000. I agree it was higher but I think the dip corresponds to the "expected" post war bounce which did not really appear. If employers held off cutting employees in case there was a bounce they could be feeling the pain of higher payrolls now without higher profits.
Hurting the markets at the open was a strong warning by Costco which said lower margins due to falling prices and higher costs would depress earnings for the current quarter. They did say sales were improving but had been below plan for the last two months. The stock was knocked for a -6.90 loss to $30.06 and represented investor feelings about companies unable to squeeze any more earnings out of their turnip.
Last night the Semiconductor Billings report showed that they rose +0.3% in June. April was revised down to 1% from 2%. The analysts tried to spin this minor gain as positive, the fourth consecutive month of gains, but they neglected to mention that it was also the smallest gain for those same four months. Flash memory chips continue to supply the gains. The SOX was not impressed and closed with a -12 point drop to 383.
Also helping contribute to the market slide was the financial sector which is getting killed on the bond action. The $BKX.x has dropped from 903 to 856 in only 3 days. The rebound from yesterday was almost completely retraced and we are nearing two month lows. With nearly 50% of the S&P either techs (27%) or financials (22%) it is not surprising that it closed at two month lows as well. The 50 DMA at 986 is well above the 965 close. With the futures trading at 959 overnight it appears the cash index will test the July intraday low at 962.10 at the open.
After the close Cisco reported earnings that were inline with estimates but they had to stretch to do it. Cisco reported that they bought back 424 million shares, 83 million in the last quarter, which reduced their shares outstanding by -3.7%. They also said they had $5.2 billion left in the current buyback program. Without the share repurchase the EPS would have been closer to +13 cents. There were several other warning signs. Inventory rose to $873 million from $765 million. Gross margins which had been expected to rise to 71% remained level at 70% and Cisco said they would be dropping to 67-69% going forward.
Last quarter Cisco earned $982 million on revenue of $4.7 billion. In the same quarter last year Cisco earned $772 million on sales of $4.48 billion. There has been no top line growth in a year and earnings have come primarily from cost savings. Cisco said expenses could rise +2-3% in the current quarter. That is a disguised way of saying that earnings may fall over the next quarter. Sales declined over the prior quarter by -2.6%. The company said it continued to see weak demand and has yet to see a material increase in IT spending. John Chambers tried to spin the results but analysts continue to focus on terms like "continues to be a challenging environment" and "Cisco will continue to curtail costs by keeping a flat headcount." Analysts said that last statement was an implied reduction in force due to attrition and other factors. Cisco basically said on the conference call that they do not see the business environment getting any worse but they also do not see it getting any better. Cisco was trading down -$1.30 in after hours. Cisco's cash flow, which Chambers normally touts as a measure of true strength fell to $1.55 billion from $1.61 billion for the same quarter in 2002. Cash on hand dropped nearly a billion dollars. Accounts receivable rose to 26 days compared to 21 days in 2002 and 23 days last quarter. Every item is just slightly worse than it was before. Not bad, just slightly worse, but analysts feel that the cracks in the armor are beginning to show.
The bond market took yet another hit today. The government auctioned off $24 billion in three year notes at a yield of 2.422%. The bid-to-cover ratio, a measure of demand, came in weaker than expected at 1.32 vs the 1.96 ratio of the last sale in May. There will be another $18 billion of 5-year notes on Wednesday and another $18 billion of 10-year notes on Thursday. This is not good news for the bond market despite the fact the auction was expected for weeks. Considering the selling in the bond market over the last six weeks, the lack of interest in government paper and the potential for several hundred billion more over the next several months the outlook for rates is not good. Once the auction was over the 10-year yield soared to close near the high of the day at 4.44%.
The stock market is not happy about this complete retracement of the Monday bond bounce. It appears it was an oversold reaction to the 100-year storm as Franklin Raines, the FNM CEO, called it. The rumors are still flying that a big bond house is in trouble and part of the Monday bounce was relief that there was no failure announcement over the weekend. With yields soaring and the market dropping, anyone in trouble last week is likely in worse trouble today. The remaining auctions this week are expected to drive prices down and yields up even further. The one-day reprieve for the homebuilders disappeared as they returned to close near the lows for the week.
It was not a good day for the markets despite the good economic news. The Dow closed at 9036, just slightly over the critical 9000 level and well under its 50 DMA at 9100. The Nasdaq closed at 1673 and only +5 points over the 50 DMA at 1668. This was the lowest close for the Nasdaq since July 3rd. The S&P took the biggest hit with a close at 965 and well below its 50 DMA at 986. Other than the psychological support at 950 the next major support level would be the 200 DMA at 940. For the broadest market view the Wilshire-5000 closed at 9306. The 9300 level on the $TMW.x is directly equivalent to Dow 9000 and it was the lowest close for the Wilshire since early July.
To put it bluntly, if the Dow closes under 9000, the Wilshire under 9300 and the S&P under 960 then the trend is over. The constant rally by the markets in the face of bad news appears to be over. They cannot even rally them on good news this week. The implications are serious. I said on Sunday I was long term bullish and short term bearish. My short term was two weeks and it appears to be acting as expected. I have running email conversations with a great many traders and market analysts and almost without exception they are expecting a short term drop. That may be a strong contrarian indicator in itself. As traders we should look at it as a long term buying opportunity developing not the end of the world. This is just a normal profit taking cycle and a normal first week of August. It is accelerated by the bond fiasco. It is also accelerated by the options expiration next week and the extreme bullish move since March. Even rumors about Saddam failed to bounce the market this week. If we break Dow 9000 then my July target of 8500 still stands as a worst case scenario. If you are short I would be looking at the 200 DMA at 8730 as decent support and an initial exit. Plan accordingly.
If the army of short term bearish traders I communicate with are a bullish contrarian indicator then I have the perfect contrarian bearish indicator. Ralph Acompora said on TV tonight that we are in a cyclical bull market that should last through 2004 and the Dow could make a new all time high. For those with short memories the Dow's high was 11,750 in Jan-2000, roughly +2750 points above our current level and a +30% increase from here. I hope he is right but considering Cisco's earnings tonight I just think it might take a little longer and start from a little lower.
Enter Very Passively, Exit Very Aggressively!