Markets are down two out of three days but we are far from a new bear market. Despite the selling and the change in internals we are still stuck in the trading range we have seen for the last week. The major difference was in the internals which could be a leading indicator of future direction. As we creep quietly deeper into September traders are looking for any clue as to when the historical trends may appear.
Economically this was not a good day. Not bad, but not good either. The Wholesale Trade report was slightly below consensus at +0.4% but down from last month at +1.6%. Inventories remained unchanged for the second month but the inventory-to-sales ratio returned to its record low of 1.52. This would tend to show pessimism that the recovery may not hold because nobody is stocking up for future sales. This is a mixed message because historically very low inventory numbers would spark a huge spike in manufacturing if demand suddenly increased. Without a recovery in sales that manufacturing bounce will not occur. The drop in sales from +1.6% in June to only +0.4% in July would be more troubling were it not for the many corporate references to a pickup in business in July. Did it really pickup or was it just a temporary post SARS bounce? We will have to wait for the August data to see for sure.
The Richmond Fed Manufacturing Survey rose to zero in August from -7 in July. While this was overall positive it was only barely so. The biggest gain was in the New Orders, which became less negative at -4, up from -13. The Backlog of Orders dropped from -17 to -20 but the six month outlook rose to 31 from 28. Smaller backlogs, order flow still negative but getting better with the outlook still improving. This was disappointing when measured by the ISM gains and all the components were below their June values. This only reflects the manufacturing in the Richmond area but it is not in agreement with the ISM. It could be a sign that the ISM is in trouble for August.
Chain Store Sales continued to rise at +0.5% as back to school sales were still ringing the registers. This was the largest gain in five weeks but now that the Labor Day shopping weekend has passed we could see some weakness ahead. The BOT-M lowered estimates for September to a +3.5% gain from +4.0% after WMT, S and TGT lowered estimates for September. Tax rebate checks have slowed and mortgage refinancing has dropped more than -80%. This will reduce the flow of spending cash until the year end holiday season begins. We will get another look at the REFI index tomorrow with the Mortgage Application Survey. The REFI index has dropped to 1981 from the May high of 9977 and loans started in May/June would have already closed by now. Only 30 days ago the index was 4145 and we have seen a 50% haircut since then. Goldman lowered its outlook on retail stocks saying the leading consumer indicators were slowing and retail stocks were trading above their five year average. Goldman downgraded most retail sectors to cautious from neutral except for supermarkets and drug stores which they left at neutral. They cut HD, LOW, FD and MAY to inline. Part of the downgrade on HD and LOW was due to mortgage rates and the impending deceleration in housing turns. Merrill jumped on the valuation downgrade wagon with a SELL on Albertsons.
Nokia depressed the market at the open after the CFO said that phone prices were falling. NOK still said earnings would come in at the high end of expectations but the falling prices comment touched quite a few players. Falling prices puts pressure on chip and component makers as well as profitability of other phone makers like QCOM, ERICY and MOT and service sellers like Verizon and AT&T. Increasing competition was given as the reason by Nokia. Falling prices can mean lack of general demand and the sector ripples were light but broad.
DB upgraded CSCO before the bell but it closed in negative territory despite a valiant try to hold the higher ground. The networking index fell -2.2% with CMVT and LU losing -6% while FDRY bucked the trend at +4.1%. 12 of the 15 stocks declined. 11 of 13 stocks in the communication index fell as well. Most of this weakness was attributed to the Nokia news but there was also fall out in the communication sector on news that WCOM had reached agreement to come out of bankruptcy leaner and meaner. This is frustrating for other companies who were hoping the company would be liquidated to cut down on competitors.
After the close today XLNX and TXN issued mid quarter updates and the outlook was not as positive as traders had hoped. XLNX said sales of its programmable chips would be flat to only slightly higher and inline with prior guidance. XLNX fell in after hours trading. TXN refined its guidance to the high end of its prior levels. TXN had said revenue would be in the $2.29 to $2.49 billion range and they narrowed that range to $2.39 to $2.49 billion. Earnings were expected to be in the 20-22 cent range, up from the 18-23 prior guidance. TXN fell -1.60 in after hours as traders were expecting the new guidance to be outside the prior range.
USB began the worry over tech valuations with comments that the current prices reflected a PE of 31 based on NEXT years earnings and those earnings were still questionable. They said the historical PE for this time in the cycle was 28. Salomon however raised chips yesterday based on an acceleration of earnings anticipated for 2004. It is all in the timing as one man's over bought could easily be another's breakout.
The NOK warning this morning was only one of a the few warnings we have had so far this quarter. According to First Call only 20% of the pre announcements have been negative compared to a normal 25% average. This should mean the 3Q earnings are going to be better than expected but then WHAT is actually expected? The market appears to be expecting a blowout quarter after Intel guided up twice. Unfortunately if you examine the earnings of the S&P companies the numbers do not add up. For the 3Q the S&P earnings are expected to jump +12% but revenue is only expected to rise +1.2%. The 4Q earnings are expected to rise +20% but revenue is only expected to rise +2.3%. Obviously the earnings ramp is huge and any slowing of revenue growth could be dangerous. The earnings are predicated on drastically reduced costs and higher productivity. (fewer workers) Everything is priced to perfection and any cracks in that perfection model could get ugly.
The current market has risen +2200 Dow points since the March lows. The Nasdaq has risen +650 points. In 1998 and the start of the great bubble the Dow only rose +1920 points, +25% from the lows. In 1999 the Dow gained +2400 points, or +27%. The current Dow has rallied +29% from the March lows. This is more than either of the bull market bubble years and has done so without any material pullback. In 1998, admittedly a strong bull market the Dow lost -1966 points from the July high to the October lows but recovered all of it to close the year higher. In 1999, another strong bull market, the Dow dropped -1389 points from the August high to the October lows and recovered all of it to close the year higher. What is driving professional traders crazy is the total lack of selling this year after a +29% gain in the Dow and a +51% gain in the Nasdaq in only six months.
What is different this time? The early 1998 Dow low was 7450 and only 34 points higher than our low in March. The market levels are basically the same. Where are the bears? Where are the profit takers? Where is the normal September weakness from portfolio rebalancing? The bullishness is so rampant there are simply no sellers. While this is not a healthy trend it can be self perpetuating. The main difference between our current conditions and 1998/1999 is the Internet explosion and the Y2K build out. PCs were flying off dealers shelves at an average price of about $2500 to beat the Y2K bug and allow buyers to surf the net with amazing speed on their new 56K modems. One hundred million PCs were sold. Quite a tech wave for those new surfers. The difference this time around is that we do not have a wave. Investors are buying techs like there is no tomorrow but the wave powering earnings is more of a ripple. Certainly nothing you could surf. Computers cost $750 now fully equipped but the dot.com surplus is still with us. I threw away two dozen 1999 computers last month because I could not sell them. The 450mhz Y2K computers were scrap compared to what you can buy today for $399 new.
My only point tonight is this. We have had a huge move in the last six months without any serious profit taking. Over $3 trillion in gains have been made in the Wilshire-5000 since March without any serious pullback. We are moving into the most dangerous six week period on the calendar and nobody appears worried. The 15 EMA on the VIX touched 20 today after the VIX closed under 19.0 last night. The last time this happened was Sept-5th 2000 and EXACTLY at the Dow high before the -1745 drop over the next six weeks to the October 18th low. The last time before that was July-20, 1998 and EXACTLY the Dow high before dropping -1900 points to the Oct-8th low. You can choose to ignore the VIX if you want and you can believe we are going to hit 10,000 before 9,000. What we believe is immaterial. The market will continue to move based on what the herd decides to do not what the various indicators and historical calendar trends say it should do. The market exists for many as the great humiliator and any of us who put our thoughts in print on a daily basis have been the object of that humiliation many times over. All we can do is point out what COULD happen and then get out of the way. An informed trader is a better trader.
The buying in the futures markets today was unbelievable. The numbers of contracts coming in at bid on every minute dip were several times the number we have seen over the last week. The dip buying was simply amazing but the market finished down. Is this a change in the trend? The most telling news for me was the Nasdaq volume at 2.2 billion shares. This was the second highest volume since May. Down volume beat up volume but only slightly at 6:5. 52-week highs at 369 beat lows at 1. Yes, one. The NYSE on the other hand had nearly 2 billion shares but the down volume was 3:1 over up volume. 52-week highs 204, lows 5. Despite the increase in down volume the internals were still very bullish on both exchanges. It was disguised because the indexes fell but it was still bullish. At least that is what it appears on the surface. Many would point to the massive volume over the last five days, over 4 billion shares across all markets each day, and the lack of upward movement and suggest there was serious distribution underway at the top. Selling is very heavy but so is the buying in order to hold these levels and somebody is going to be wrong.
What direction you believe in will not change with this article. That is fine I am not trying to tell anyone that we are going up or down. I am only trying to alert you to the possibilities. Nothing is ever guaranteed. In 1995 and 96 there was no October dip. In 1994 it was so small as to be insignificant to the overall picture. In 1997 and the beginning of the Internet trading revolution it was only -1300 points. There is no right answer to what lays ahead. If you are prepared there is also no danger. Keep those stops tight and think about some index puts for insurance. Remember the Boy Scout motto and "Be Prepared".
Enter Very Passively, Exit Very Aggressively!