The Music Stopped
If you read my wrap from Thursday night you know what the title means. The move to the sidelines was orderly and patient but it was persistent. The difference in sentiment between the open and the close was as different as night an day but in reality nothing changed. The Nasdaq dropped -46 points from its morning high but only ended down -12 points for the day and up +63 for the week. Yes, it was a dramatic move but all things considered it meant nothing.
Economically the day was a dud. The ECRI (the who cares report) was flat again at 127.6. The only material change was in the 6mo growth rate which fell to 12.7 from last weeks 13.2. No big deal here. Cooling home sales and rising interest rates are dampening the growth in this index.
The only other report was the Internet E-Commerce Sales for Q2. It came in at $12.48 billion and up from $11.93 billion in Q1. Sales were up +27.8% from Q2-2002. While dollar volume is rising the percentage of Internet sales to all sales is dropping slightly. It was 1.59% in the 4Q-2002 and fell to 1.45% in Q2. Most analysts had expected sales volume to drop instead of rise but the overall impact of the report was negligible.
Nobody cared about the economics because Intel surprised everyone by raising guidance before the open. Futures rocketed from 1002 to 1012 between 8:30 and 9:30. The markets opened up at new highs with Intel in both the Dow and the Nasdaq. The Dow raced to touch 9499.97 and a level not seen since June-20th 2002. Weekly levels of resistance were blown away in a few ticks but the index fell .03 short of touching the electric fence at 9500. The Nasdaq hit 1812 and a level not seen since April-19th 2002. The sun was shining, birds were singing and everybody was praising Abby Cohen and her latest earnings upgrade for the S&P. That all happened before 10:AM.
When the clock struck 10:00 the bull's tech express turned into a pumpkin and the wheels quickly fell off the rally. I say this only tongue in cheek because nothing has really changed. The drop from the highs of the day was dramatic but it occurred on low volume and it was very orderly. Decliners beat advancers 2:1 but new highs still hit 721 and new lows only 53. The VIX was not off or under the scale with a low of 19.41 but it has climbed for four days from its 19.06 low on Monday. No news there. So what derailed the tech express in light of the Intel announcement?
Intel itself was the primary cause of the change in sentiment. Intel CEO Craig Barrett went on record Thursday by saying they were seeing some selective buying in PCs but he qualified it with "We're not seeing a big upgrade cycle and we're not seeing IT budgets being raised." Ok, we can all buy that and thank you for the clarification. He knew what was coming and wanted to blunt the reaction. Friday morning Intel raised revenue estimates from +6% growth to +11% growth for the quarter over last year and raised the gross margin to 56% from 54%. The new $7.55B estimate was higher than the consensus estimates of $7.24B by about $300M. The margin gains are being fueled by a move to the higher end products like chips for notebooks and servers. We have heard from Dell, HPQ and GTW that PC sales are soft with the only consumer interest in laptops. Servers are so cheap that companies are beginning to selectively upgrade but the real key was the stronger than expected back to school bounce.
Consumers are taking their tax checks and refi funds and buying new computers for students. Intel said they did not see it coming because of the very low visibility in the market. Also helping them is the price war between Dell, HPQ and the white box makers. The prices are so low for the commodity PC that retail buyers are being lured into the back to school market where they would not have ventured before. The $499 computer is flooding the market and the only winner is Intel. The box makers all buy the same chips and they are cutting their throat on the sell side to keep the volume up. You can imagine Intel's delight to see the chips flowing out the door like cocaine to street dealers. There is no profit in the food chain unless you are at the top and everybody is continuing to deal just to support their habits.
Intel said other chips remain soft and Andy Bryant tried to tone down the excitement with several well placed comments. He said it is unclear if the unexpected bounce in the early part of the quarter would continue in the coming weeks. He said their chip plants were running at nearly full capacity and they were experiencing some shortages. That is a problem he would love to face in light of some plant closings over the last couple years. They are leaner now and shortages would keep prices up. Part of the higher margin guidance is because they have not lowered their prices this quarter. This is a good sign that they do not feel pressured by lack of demand.
So what caused the sell off? On the conference call Intel refused to give any specific guidance or answer any pointed questions. They said the bounce might only be a temporary result of the Dell price war in anticipation of back to school sales. There was some veiled rumors that it was the result of some channel stuffing and volume requirements of dealers to get decent prices. They repeated the claim that IT spending was not improving and they had limited visibility going forward. Considering they just raised guidance the conference call was anything but bullish. They raised our hopes and then popped our balloon. However it was not the first time this year for this to happen. In June Intel raised guidance with the following comment. "The company's Intel Architecture business is trending to the high end of the normal seasonal pattern while demand for communications products remains soft. All other expectations are unchanged". With that comment Intel gapped open and capped the end of a two week rally. In March Intel saw the exact same bounce into the guidance statement only they guided to the lower end of the range. The bottom line here is that it does not seem to make any difference what they say. The smart money has already bought the rumor and they sell the announcement. Note the SOX chart shows an even more drastic reaction to the Intel news.
On the trading floor the thought process was more in the "so what" category. Everybody has been buying the rally for several months in anticipation of exactly what Intel failed to say. They did not want to hear a few computers were going to be doing school work. After 2-4 weeks that boom will be history. They wanted to hear that companies were dumping in mass their Y2K dinosaurs and stepping into the Star Wars generation. They wanted to hear that budgets were being raised +15-25% to add infrastructure in the form of servers and routers. The markets did not get what they wanted. They did not get what they thought they paid for over the last three months. Instead of confirming the recovery Intel went out of their way, twice, to say there was no real improvement in IT spending. There is some evidence that small businesses are starting to crack their checkbooks but they have yet to brush away the cobwebs.
The market flamed out on Friday like a rocket that had run out of fuel before reaching orbit. It was spectacular but far from the beginning of a new bear market. Even with the drop the Nasdaq still finished +63 for the week. While the Dow at +27 was less exciting it still finished the week positive. Both indexes are still at the upper end of their trading ranges and even with the -150 drop off the Dow's intraday highs it still closed right on support that has been resistance for three months. This is not an ugly picture. The uptrend support is still intact.
The Nasdaq closed -46 points off its high, oh my! So what? The Nasdaq had jumped +172 points since the 1640 low on August-8th. In only 10 trading days it had climbed +10.5%. Read my print, profit taking was due. Still it only fell back to just below the uptrend resistance at 1767 from August-2002. Not a shabby performance and a perfectly logical place to stop.
The most disturbing chart for the bulls is the S&P-500. The S&P has failed to confirm the Dow or Nasdaq and failed to break or even hit the two prior highs at 1015 from June and July. This is very troubling for the bulls but for traders it has been very profitable. The "buy 960,short 1000" trading plan has been working so well that traders hate to part with it. The constant range bound market is still in place on the S&P. The failure to break to a new high formed a triple top on the S&P and the normal pattern would be for the next test of 960 to fail. I doubt it will do that next week with the bullish undertones to the market.
The problem is not next week but next week could be a problem. Confused. Typically the week before Labor Day is worthless. The volume is so low you can go to lunch and not miss a candle. Many traders take off the week before Labor Day. Considering we are entering the holiday week on a down note it could set the tone and with low volume drift lower. Volume is a tool of the bulls and markets do not hold major up moves without it. We have had very low volume this week and you see where we ended. We had lots of volatility and lots of movement but no conviction. It was all knee jerk reactions to news events. Nobody has yet to explain to me why Chemical Ali was bad for the market and why his capture was bullish.
The problem is actually the next week. When traders come back from the Labor Day holiday they typically are ready for a change. The institutions begin thinking about taking profits before the October dip and their year ends. They will lighten in September and buy the dip in October. In 1929 the market top came on the day after Labor Day. In the last 75 Septembers only 30 have finished with a gain. Portfolio managers come back from the Hamptons with a broom in one hand and a financial statement in the other. Dump the losers and take profits on the winners. The day after Labor Day is normally bullish, up 7 of the last 8 years, but the excitement ends there. The September end of quarter portfolio restructuring is the worst quarter of the year. Will that happen this year? Nobody knows but with huge gains after a three years of losses it is a sure bet the funds will want to capture some of them before they get away.
A tidbit I picked up on Friday may give us a clue. Insider selling is typically a leading indicator of market health. If they are buying then the outlook for their company is strong. If they are selling the outlook is weak. According to trackers when the insider selling reaches 20:1 over buying it is bearish. Currently sellers are running 35:1 over buyers. It has been over 20:1 for four months. What do Gates and Dell call it? Diversification. Michael Dell's wife diversified by selling one million shares last week. $32 million in back to school money for the kids. Michael sold 10 million last week. $320 million will buy some real toys. With 268 million shares left they are going to need a lot of diversification. Michael if you are reading this I am available for adoption.
The economic calendar begins with Existing Home sales on Monday, and Durable Goods, New Home Sales and Consumer Confidence on Tuesday. Skip Wednesday and pickup GDP, Chicago NAPM, Help Wanted and Monthly Mass Layoffs on Thursday. Friday has Personal Income, NY-NAPM, PMI and Michigan Sentiment again. The confidence and sentiment numbers should be critical as well as the Chicago and NY NAPM reports. As long as there is no critical damage in these then the rally should continue with time outs for profit taking. If anything the sell off on Friday took the pressure off the shorts. They are no longer looking for high windows and will be breathing easier over the weekend. Bulls are already deciding where they can pick up some more bargains. Which side you are on depends on whether you see the glass half full or half empty. Personally I think the irrational exuberance from last week filled it to overflowing and we need to pour a little out before we can continue the process. There is no clear answer but as long as the earnings and economic news continues to improve the profit taking may be brief.
Enter Very Passively, Exit Very Aggressively!