Ok, Now What?
The long awaited FOMC meeting is history and the outcome was no surprise to anyone. The Dow rocketed to close over 9300 and the Nasdaq is nearing 1700 once again. What is wrong with this picture? Conviction, total lack of conviction and growing disbelief that the economics will hold. Bears and bulls alike are scratching their heads as the indexes move up but the confirming volume is continuing to shrink. Today was the second lowest volume day, behind Monday as first, since May with less than three billion shares for the third consecutive day.
Two economic reports today were far from positive for the bulls. The Chain Store Sales rose only +0.1% from the prior week despite sales tax holidays in six states and the second wave of tax credit checks. Back to school sales are reportedly off to a strong start but with only a +0.1% gain in sales it would appear anemic.
Even more troublesome was the Richmond Fed manufacturing Survey which came in at -7 for July. This was a substantial weakening of the conditions and every component lost ground. New Orders fell to -13 from zero, Shipments fell to -7 from +1. Order Backlog fell to -17 from -15 and the six-month outlook fell to 28 from 41. There was nothing positive in this release and after two months of improvement it appears the trend has reversed. The survey showed four consecutive months of retraction which ended in June with a barely positive +1 for the headline number. The drop back into negative territory was the worst showing in three months. Expected shipments fell to the lowest level since October-2001. This report was in sharp contrast to the national ISM survey announced last week, which showed an improvement in conditions. If the Richmond Fed Survey is a leading indicator for the August ISM then we could be in trouble.
Note how the Richmond Fed has performed in relation to the ISM over the last seven months. It actually was more positive in the June period but we see significant divergence in July. One problem with the ISM bounce was the 44% increase from defense spending which inflated the ISM. Without those defense numbers the ISM may have been much closer to negative. More analysts are beginning to worry that the bounce in the July numbers across the board were a reaction to the temporary post war economic bounce. If that bounce fails to grow legs soon the fall economic recovery could evaporate once again.
After the close today there were some more discouraging signs that all is not improving as much as traders had hoped. AMAT announced earnings that beat the street after one time items but then guided analysts lower for the coming quarter. New orders fell -41% from the year ago quarter but +9% above the 2Q. The company said the semiconductor sector appeared to have bottomed after a three year spending drought but then guided analysts that revenue would be flat to only slightly up for the next quarter. They estimate earnings of 4-5 cents when analysts consensus was six cents. The CEO said expectations were high that users would upgrade to the new 12 inch wafer products but he said that bookings were less than expectations. AMAT said it appeared capex spending would be flat to only slightly improved over 2002 levels. AMAT fell in after hours trading.
Also reporting after the bell was MXIM, which reported inline with estimates said bookings for next quarter only rose +2% and were less than analysts had expected. CSC also reported inline with estimates but said the harsh climate has resulted in a slow-down in corporate spending but government contracts had held up well. They currently have $38 billion in federal contracts in the pipeline. They guided inline with estimates but some analysts said the slow down in non-government orders was a concern.
The biggest news of the day was the FOMC meeting and the monetary policy announcement. The results were as expected with no rate change and with the Fed even going so far as to say the current rate environment could be maintained for a considerable period. This comment was an attempt by the Fed to calm the bond market and slow the current explosion in rates. This does not mean those rates will return to prior lows but there should be a return to normalcy. Coupled with the implied promise not to raise rates was another warning that deflation, or "the risk of inflation becoming undesirably low" as stated in the announcement, was still a threat. They said that "an unwelcome fall in inflation" was greater than the risk of rising inflation. On the positive side they said underlying growth in productivity was continuing to support economic activity (same sentence in June announcement) and spending was firming.
The Fed did everything they could to say positive things while keeping irrational exuberance in check. If they were too bullish then the bond junkies would start dumping bonds and pushing up rates. If they were too bearish stocks would tank and damage the recovery sentiment. The markets celebrated the Fed action but not immediately. Nearly 30 minutes passed after the announcement before a flurry of buy programs at Dow 9200 support pushed the averages to the highs for the day. Once the buy programs ended the markets bled points for about 30 minutes until a market on close order imbalance prompted another buying surge. Shorts faced with indexes pressing the highs for the day, week and month decided to surrender and bought the close. The Dow closed over 9300 and the highest close in over a month. Only -50 points from the 52-week high it was very encouraging to traders.
While the close was impressive the week is far from over. The economic calendar is chock full of large reports over the next three days and this is a triple digit expiration week. We have PPI, CPI and sentiment along with numerous other reports. The earnings expectations are very high and as we saw from AMAT, MXIM and CSC tonight the future is not that rosy. Above all the Fed announcement was already priced in and the market reaction surprised most professional traders. Tuesday was the fifth consecutive gain for the Dow and a +310 point gain off last weeks lows. Also confounding the bears is the calendar. August is historically the worst month for the major averages and especially when there have been big gains. Instead of weakness we are seeing new 52-week highs beginning to grow and the volatility indicators falling. The VIX closed at 20.21 and only .58 away from a new 52-week low. That is only .28 away from the July 28th low of 19.93 and the beginning of the two week Dow decline. Note the market reaction in the charts below when the VIX neared 20 in recent weeks. It is not always immediate but it will happen.
You be the judge. We had a nice rally and a nice bout of normal profit taking. Was it enough? There are still very large paper profits still on the books. With the Fed on hold until after the Nov-2004 elections and economics that suggest the bottom is behind us, is the future so bright we need to wear shades? Nobody can tell the future in advance but it appears there continues to be a bullish undertone in the markets. Bulls are buying the dips and climbing the wall of worry so fast they look like candidates for the Olympic pole vault. Last week we had serious sell programs hit on every good piece of economic news. Today we had buy programs control the outcome. What gives?
There is only one thing ruining this picture. Without this one piece of data all the gains over the last five days are seriously at risk. That piece of data is volume. We had the three lowest volume days in months beginning last Friday. Volume has been declining since last Thursday's 3.98 billion. Friday 2.9B, Monday 2.68B and Tuesday 2.8B. Three consecutive days under 3.0 billion shares traded on all markets. When volume returns we are going to get some huge moves. The problem is which side is going to find the conviction first? Were the bulls waiting for the Fed meeting to validate their assumptions so they could add to positions? If so then the upside volume should increase substantially on Wednesday.
Were the bulls waiting for the Fed and hoping to get one more injection of speed to inflate their parachutes as they sell to the retail traders venturing back into the market? Maybe the bears were waiting for the Fed meeting to avoid any nasty surprises before piling on for the slide into October. Nobody knows in advance but they will know when the next big volume surge hits stocks. Tomorrow, Friday or next week is the question. We are at levels where the bulls have failed on high volume several times before. They will have to enlist help to climb from here. There is plenty of help out there but it needs to be convinced to buy at the top. Everybody know what normally happens in September/October and until they can be convinced the Halloween party has been cancelled they may elect to watch from the sidelines. Either way the next week could be exciting. Watch the volume for direction.
Enter Very Passively, Exit Very Aggressively!