If you live in the Northeast chances are you are reading this newsletter a little later than usual due to the lack of power. Fortunately the markets had closed when the disaster began and the disruption was minimal. The disaster is going to occur on Friday morning if the power does not come back online soon. The challenge is not going to be the NYSE computer systems but the massive dislocation of thousands of traders and support staff.
Dow Chart - Daily
Nasdaq Chart - Daily
When the lights went out in New York at the close on Wednesday it immediately created an urge to exit the city even if walking was the only mode of transportation. Trains, subways, airports and communication were immediately knocked out and streets and bridges were jammed with pedestrians moving quickly away from town. Even cell phones ceased to function without base station support. With hundreds of trains and subway cars stuck in tunnels the urge to find ANY alternative exit in case it was a terrorist attack was strong. People were literally running away from the city. At one point authorities estimated there were over 20,000 people jamming streets around a single ferry terminal to New jersey.
New York is a commuter city and with no way out people were literally lining up by the thousands at bus lines and ferries. The problem will come tomorrow when these same people try to get back into the city to pick up their lives where they left off. Since the problem appears to be a grid failure from the heat generated overload there is always the possibility of another failure on Friday. That possibility may only be in the minds of citizens but it could wreak havoc to the normal business cycle. Many New Yorkers may simply decide to stay home and that could be the best decision. This means that trading on expiration Friday could be very hectic at the open followed by very light trading the rest of the day. With many funds and institutional traders in the New York area those operations could be running with a skeleton staff. The city of New York has assured everyone the power will be restored sometime tonight but should it not return the sentiment impact could be strong.
Because the outage covered multiple states there were about a dozen airports closed. Some estimates were between 7-10% of all U.S. airline traffic for the day was either delayed, rerouted or cancelled. Planes headed for the Northeast were rerouted to airports several states away in some cases. This means those passengers will not make connections and not be home until tomorrow night. Planes scheduled to be in some other part of the country for the start of business tomorrow will still be somewhere in the Northeast. Flights from Miami, Dallas, LA etc will not be there because the planes were grounded overnight in the Northeast. It could be Monday before all the equipment can be rerouted to catch up with their schedules.
The morning started off calmly with Jobless Claims rising to 398,000 and last weeks claims revised up by +6,000 to 396,000. This was the fourth week under 400K but we are rising steadily toward that number. In the last four weeks beginning with July 19th we had 391K, 392K, 396K and ending with 398K this week. Analysts have made a big deal about the four weeks under 400K but you can see by the numbers we are moving up again. Also, the prior three weeks were adjusted to account for historical automaker layoffs for retooling in July. Now that this period is over we could see these numbers begin to rise again. The four-week moving average rose to 3.63 million. 29 states reported an increase in claims for the week.
The PPI came in as expected at +0.1% with the core rate at +0.2%. Core intermediate prices fell slightly and have posted no gains since the first quarter. This is normally a leading indicator for consumer inflation and it is showing a move toward deflationary conditions instead. Prices for finished consumer goods also fell. There is nothing in this report to excite either the bulls or the bears as the changes are minimal.
The minutes to the June FOMC meeting were released and the Fed heads were pleased that their "unwelcome fall in inflation" statement had pushed interest rates so low. The minutes showed no indications that they had a clue rates would rebound so quickly. They were confused as to why the economy had not rebounded and felt sure it would soon. Still stuck in denial it seems. The 25 point cut in June was not unanimous and Parry voted for a 50 point cut and one member voted for no cut. The main concern was the wording of the statement to make sure they clearly expressed the reason for the cut. In other words they spent a large amount of time trying to say deflation without using the D word. We now know they miscalculated by only cutting 25 points when the bond market clearly wanted a 50 point cut. When their actions failed to match their words the bond market revolted.
The FOMC minutes did not excite the bond market and bonds fell significantly. Yields on the 10-year rose to a new 52-week intraday high at 4.668% and closed at 4.586%. This is much higher than the August 1st panic highs. This two-day sell off after the FOMC meeting this week shows the bond market is still not impressed with the Fed's action or lack of action. The problem is still rampant selling or dumping of bonds by mortgage lenders, funds, institutions and even countries. There are rumors that the rising deficit, which could approach a trillion dollars next year, has caused several countries to dump debt. Rumors are that Japan and China have told the U.S. they were not going to buy U.S. debt until the deficit is under control. Suddenly there are only sellers and no buyers. The 23 primary dealers that took down the majority of the $60 billion in the bond auction last week at a 10-year yield of 4.36% are seriously underwater.
Ten Year Yields
The markets performed very well despite several high profile problems. TGT missed earnings by a penny before the open and while that contributed to the morning dip it was quickly shrugged off. MMM was cut by Smith Barney on valuation concerns. CSFB cut techs in general on worries about demand but the Nasdaq shook it off early. The Dow moved over 9300 and stayed there most of the day despite the soaring bond yields. The Nasdaq closed back at 1700 with Dell earnings looming over the market at the close. It was a very positive day with a strong bid under the market but not enough volume to push it higher.
Dell reported earnings inline with estimates but the entire event was ignored due to the power outage which occurred about 4 min later. Dell reported 24 cents and said demand had stabilized but had not significantly improved. Michael Dell said CEO optimism was increasing but not enough for him to characterize it too strongly. He said it would take a couple more quarters before he expected budgets to begin to increase. Michael, would that be before the second half of 2005? Dell saw margins shrink due to a slowing in the rate of decline in computer parts. Many components are already selling for much less than the cost to manufacture them but factories cannot afford to stop production due to the expense of restarting and rehiring when demand returns. This means costs are not going to get any cheaper and we could get a further margin squeeze on any future demand.
When you can buy a 125GB Maxtor hard drive for $89 and 256MB of DDR memory for $39 there is no margin left. When Dell sells a 2.2GHZ Pentium IV with a free flat panel monitor for $599 how much money do you think they make? Analysts think $20 bucks or less. They make their money on the laptops, servers and accessories. It would not take much of a component cost increase to put the squeeze on Dell. With computers now a highly competitive commodity and consumers constantly being bombarded with low price specials it will be difficult to command higher retail prices when the trend changes. Most consumers will balk before paying over $599 for a long time after the costs change.
Volume continued to be extremely low with total volume under 3.0 billion for the 4th time in five days. The volume has been under the 50DMA for 17 of the last 25 days. This is summer when volume normally slows but it has been much slower than normal. The good news is the steady climb in the markets on this low volume.
Tomorrow we have some critical reports. The most critical for me is the Capacity Utilization. It has been 74.3 for the last two months and a low not seen since 1983. Analysts are hoping for a bounce over 75% but will probably be happy with anything higher than 74.3. Any drop in this number and bad things will happen because it would indicate more potential layoffs and a further unwelcome decline in inflation as competition increases. It would mean no need to upgrade or buy new equipment and no increase in capital spending. Also closely watched will be the first Michigan Sentiment for August. The final July reading was 90.9 and with other surveys showing a drop in sentiment analysts are worried the headline number could drop into the middle 80s. The New York Empire State Mfg Survey also showed a drop last month to 22.6 and if it follows the last NY NAPM report it could fall back below 20. All of these reports are at a critical stage and this could be a turning point for the markets if they were to show weakness.
Friday is also option expiration day and from the late reports on the news it appears the markets will open for business at the regular time. The maximum pain numbers where the most options expire worthless are either at or below the current market levels, OEX 495.00, QQQ 31.00 as examples. This should keep the indexes pretty close to level unless the economic news is very good. Expiration Fridays lately have been tame but the economics at the open will rule. Might be a good day for New Yorkers to stay home after all.
Enter Very Passively, Exit Very Aggressively!