Option Investor
Market Wrap

New Highs Before New Jobs

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      11-06-2003           High     Low     Volume Advance/Decline
DJIA     9856.97 + 36.10  9870.60  9773.12 1.77 bln   1848/1341
NASDAQ   1976.37 + 17.00  1977.91  1953.34 2.14 bln   1782/1325
S&P 100   523.84 +  3.59   524.27   518.14   Totals   3630/2666
S&P 500  1058.05 +  6.24  1058.94  1046.93 
W5000   10324.30 + 61.20 10330.54 10220.74
RUS 2000  542.94 +  4.03   542.95   537.08 
DJ TRANS 2985.49 + 52.80  2985.49  2924.50   
VIX        16.74 -  0.12    17.37    16.62
VXO VIX-O  17.58 +  0.02    18.60    17.58
VXN        25.35 +  0.15    26.14    25.27 
Total Volume 4,279M
Total UpVol  2,910M
Total DnVol  1,322M
52wk Highs  854
52wk Lows    23
TRIN       0.77
NAZTRIN    0.63
PUT/CALL   0.77

Bullishness breaking out all over on positive economic news and hopes for good news tomorrow. The Nasdaq led the day on the strength of Cisco earnings and it rescued the Dow from a sure sell off. Traders bought the rumor of a good Jobs report tomorrow morning and the indexes closed near the highs of the day.

Dow Chart

Nasdaq Chart

Starting the day off was the Chain Store Sales for October at +3.2% and nearly half the +5.9% rate for September. The same store sales rates across various retailers painted a picture of weather related slowness with warmer weather delaying the purchase of winter clothes. Halloween goods were reportedly strong but seasonal apparel was weak. The Bank of Tokyo is currently projecting a rebound to +5% growth in November and +4% in December as the economy continues to recover and comparisons with a weak 2002 become easier.

The biggest surprise for the day was the huge drop in the Jobless Claims. The claims for last week dropped -43,000 from the prior week which was revised up to 391K just as we expected. The very unexpected drop was well below the consensus estimates of 376,000. This dropped the four-week moving average to 380,000 and its lowest level since Jan 2001. Any level under 400,000 signifies a stabilizing labor market and a number under 350,000 indicates a recovering labor market. Continuing claims have also fallen below 3.6 million for the last three weeks. This huge drop in claims is similar to the drop in 1992 when the economy was recovering from that recession and the Iraq war. Hopefully this is the start of a new trend. You know I cannot let this extreme deviation from the norm pass without expressing doubts about the numbers. Of the 52 states/territories that report claims ONLY SEVEN actually reported a drop in claims. 45 reported a rise in claims. Initially I immediately thought California must have had an impact on the drop due to the fires but they actually reported an increase of +13,539 for the week. I cannot find anything that would explain the drop given the state ratios but I would still be skeptical until next weeks revision. The market was also skeptical. There was a very small spike on the announcement which immediately sold off and no gains for the entire morning.

Other bullish data that was also ignored was the Productivity for Q3 which increased at a whopping +8.1%. This was the biggest jump since Q1-2001. Helping fuel this gain was an increase in the hours worked. This increase in productivity was also due to the continued trimming of the work force. Fewer workers, longer hours, restructured manufacturing plants and more orders produced more output. The constant pressure to raise earnings in a down economy has forced employers to do more with less. The faster the order demand increases the more productivity will jump as the basic lines are in place and capacity utilization is still only in the 75% range.

Last night Cisco beat estimates and soared in after hours trading. Overnight the futures sold off substantially from those highs after the Nikkei dropped -285 points despite the reasonably good tech news. After the very good Jobless Claims and high Productivity numbers this morning there was no bounce at the open and the Dow sank to support at 9780 right out of the gate. Traders were in shock again. Just like the very bad Layoff report earlier in the week they just did not know what to do with the numbers. If they were ready to sell good news it was more good news than they were ready to accept. The Dow hugged support at 9780 until just after noon and actually absorbed a very large amount of selling in that range. The volume was very strong until about 11:30 as the battle for control was fought and then it just suddenly stopped. The markets remained soft but slowly saw a pickup in the buying as the afternoon progressed as bulls bought the jobs rumor and shorts covered just in case the rumor was true.

The rumor is of course the Nonfarm Payrolls on Friday. The consensus estimates run from +50,000 to +63,000 jobs. The whisper numbers run from +125,000 to a whopping +200,000 jobs. Helping to fuel this rumor were comments from both Greenspan and Bernanke on jobs growth. Sound familiar? Remember last month when five Fed heads hit the airwaves the day before the Payroll report with strong comments on the jobless recovery? The various comments led investors to believe that the jobs number was going to be a disaster and everyone was shorting heavily ahead of the number. The actual number was for a gain of +57,000 jobs and the market exploded on short covering after the news. Of course the Fed heads already knew the number when they went on their speaking binge. It was a perfect setup and the markets fell for it completely.

Using the same thought process we discussed on the monitor today what we should expect after the Greenspan/Bernanke two step on jobs. Adding in the -43,000 drop in jobless claims and traders were thinking moon shot. First, the Jobless Claims were for last week and are only an advance number and will not be a factor in the payroll number. The payroll number is based on a survey done around the third week of the month. The jobless claims were in the 391,000 range for that week. This produces a potential for a disappointment on Friday. The +57,000 gain last month was the first gain in seven months and well over the consensus estimate of -25,000. Now, since the dynamic duo knew the outcome before they started speaking today were they trying to give investors hope because the number is going to disappoint or were they just trying to jump on the popularity wagon to push a positive release to even better heights? We will not know until tomorrow but the markets are setup for a potential disappointment if the consensus numbers are not beaten.

Still what will a disappointment mean to the markets. With the rally on the bad layoff news this week it appears the markets are bad news driven more than good. We sold off on the good Jobless and Productivity and rallied on the layoffs. Everyone believes there is a recovery in progress and every piece of bad news we get now will just keep the Fed on the sidelines longer. It is a bad news/good news joke in progress. Despite the positive reports this morning the Fed Funds futures are still not predicting any change until May. This and the "considerable period" comments from the Fed have taken the risk out of the bond market for the near term and should continue to fuel the recovery. The first quarter will see another round of tax checks to help the consumer sector and that should be the final shot that the Fed will ignore before the rate hike cycle begins. If they could I am sure they would like to wait until Q3-2004 and give the home builder sector one more massive injection of liquidity before the lid slams shut. The Fed Funds rate is not the real controlling factor for consumer interest but the bond market controls that sector. The bond rates are already rising and that will put pressure on the recovery but they cannot get too far ahead with the Fed funds at one percent.

A bigger challenge to the market this month is the mutual fund trading scandal. Every day the number of funds under investigation grows and now the investigation is moving into the brokers who recommended those funds. The NASD said today they had found problems with a dozen major brokers and were expanding their probe. The evidence of the impact of the scandal came in the cash flow numbers today. Remember two weeks ago when TrimTabs was saying that October could go down as a record month for inflows with an estimated $30 billion? Surprise, October flows slowed dramatically with the advent of the probes and the current tally shows October ending with only $17 billion in inflows. That $13 billion drop from the estimates could easily have been a result of offsetting outflows or simply a hesitance to put more money into funds that may be guilty. Two weeks ago funds saw $4 billion in inflows, last week only $1.2 billion. If the spigot is tightening until the scandal is over then we could be in for a long dry spell. There are rumors of an impending settlement with funds but we are far too early in the process to know how each fund may be impacted by the settlement. It could literally be in the billions and it could cause some funds significant cash flow problems. I think this may be the sleeping giant that could awaken to bite us.

We got some more good news today from the Semiconductor Industry Association. They upgraded their estimates for revenue growth for 2003 to +15.8% and to +19.4% for 2004. To put this into perspective the 2002 growth was only +1.3%. This is good news for tech stocks and chips in general as it means the top line is increasing. This helped push the Nasdaq to close at 1976 and only a stones throw from 2000. This was another new 52-week high for the index. The semiconductor index hit a new high of 525 on the news.

The stage is set for Friday. Dow 10,000 and Nasdaq 2,000 are just one strong move above us. A blowout Jobs number could cause massive short covering and bullish buying and we could easily hit those numbers at the open. EXCEPT that this would be too easy. There was some short covering into the close but it was limited. Very few people appear to be either short or concerned about being short. The Jobless Claims this morning should have sent the indexes to news highs at the open and it fizzled well before the open. Blowout good news could actually have a reverse impact on the markets. If jobs suddenly rocketed to +200K as some whisper numbers expect then bonds would get killed as well as stocks based on an acceleration of the rate hike time table. You saw it this morning. Great news and no positive market reaction.

That leaves us with a quandary. If the number is good and the market sells off do we buy the dip? Worked every week since March. If the number is bad do we buy the dip? I believe that whatever happens the indexes are still shooting for the 10000/2000 mark and traders will find some way to justify buying stocks this close to the psychological target. This could actually be investor suicide but bulls are not interested in that concept. The general consensus among traders (not investors) is the plan to short 10K/2K with both hands. Regardless of what scenario pushes it to that level the plan is no secret.

Now, we all know what happens when the entire trading community agrees on a single plan? Disaster. It could be a monster bear trap. The Fed has already shown that is has no fear of doing whatever is required to juice the markets. If ever there was an opportunity to catch traders off guard this could be it. They could be feeding the market just enough to keep the bullishness going until we get to that level. Once all the bears load up on shorts the Fed could trigger a massive support program and we blow out the top to new highs well over 10K. I know there are a lot of readers that think this is heresy. However one of the Fed mandates is to power the economy and one way to do that is the juice the markets. Governments buying securities happens all the time and it would be no stretch of the imagination to have Greenspan strike a deal with an Asian country that is hoarding dollars. They could easily put those dollars to work in our markets when signaled and actually make a profit on the deal. The Fed intervenes in markets for them on request so turnabout is fair play. Obviously this is just speculation but there have been so many unexplained buy programs at key turning points in the past that it would be easier to believe this scenario than one where millions of investors suddenly decided to invest their life savings in the market at the same exact moment. Don't fight the Fed. That axiom did not just appear over night. It has been around far longer than most of us have been trading.

The bottom line tonight is uncertainty. Nobody knows what will happen at the open but I would expect the better odds are for a sell the news event than an explosion on good news. Either way if we do not have a big market move by noon trading will probably go dormant and attention will shift to the Richmond and Kansas City Fed reports on Monday. We are at the highs and earnings are over. The VXO is still around 17.50. Funds are in trouble and traders could be disappointed by the Jobs report. Tomorrow may be a tossup but next week could be a challenge.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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