Too Much Good news
Can you have too much good news? Apparently too much good news is not good medicine for the markets. After a week of constant increases in various economic reports the Dow finished down -47 points for the day and up only +8 for the week. The Nasdaq rose +38 for the week and came within 8 points of N2K but also sold off Friday on the economic overdose.
While the Jobs Report was the economic home run on Friday there were other base hits. The Wholesale Trade numbers rose +0.5% when expectations were for a drop of -0.2%. Inventories rose +0.4% and Sales rose +0.5%. This put the inventory to sales ratio is at an all time low of 1.20. This continues to paint a picture of a coming boom from inventory replenishment once demand increases. The increase in sales by +0.5% is providing hope that we are entering that cycle.
Also adding to the recovery was a huge bounce in consumer credit of +$15.1 billion when estimates were for only +$5.5B. Despite a slowdown in auto sales the non-revolving debt was the fastest grower. No signs of a consumer slowdown here. This jump was a nearly +10% annualized rate and the fastest pace since January. This buoyed the hopes of analysts that the 4Q holiday season could be strong.
By far the biggest dose of reality came from the Jobs Report. The economy added +126,000 jobs in October and double the consensus estimate of +60K. If that was not good enough the +57K gain for September was revised upward to +125,000 and the -41K for August was revised up to +35K. This was clearly an out of the park homer with the bases loaded. The net job gain over the last three months was a whopping +286,000. Suddenly the jobless recovery became a jobs recovery and analysts could not raise estimates fast enough. This was the strongest one month gain since January. The majority of gains were in service sectors with manufacturing still losing -91K jobs over the last three months.
While the gain of +286,000 jobs was great it still has not put a dent in the unemployment rate which is still 6.0%. Over 8.8 million workers are still unemployed. A sustained jobs growth of 150,000 per month is needed to overcome the normal growth in the workforce. I am not complaining but just explaining. The +286K is light years ahead of the trend for the last year and a solid foundation for the current economic recovery. Analysts and traders have constantly claimed that the recovery would not be official until the job creation caught up and this is a significant step. Add in the huge drop in Jobless Claims to 348,000, the jump in Productivity by +8.1%, GDP to +7.2%, ISM to 57, ISM Services at 64.7 and a +6.5% jump in semiconductor billings and you have clearly the best economic news in months if not the entire year. What did the markets do with this news? They traded mostly sideways with the Dow gaining only +8 points for the week.
Ok, now what happened? Why did the indexes suddenly swoon on the good news? As I explained in my commentary on Thursday the news is simply too good for investor sentiment. The Fed has said repeatedly said it would remain on the sidelines for a "considerable period" of time to allow the economy to ramp up before adjusting rates. Before Friday's reports the futures were not predicting the first rate hike until May with the second one not until the 4Q-2004. A considerable period of time considering the extremely low rates. After Friday's reports the futures are now showing an 85% chance of a hike in March. The jump in the date by a couple months is very material and is causing a rethinking of market planning.
The next Fed meeting is four weeks away and the worry now is that the Fed will take the "considerable period" statement out of their announcement and possibly change their bias to tightening. This is a major change of direction and institutional investors will have to rethink their bond and equity allocations. I hate to keep repeating this but markets typically discount 3-6 months ahead and the flat Fed until May had already been priced into the market. Shortening that period by 30% puts the next rate hike and the changing of bias by the Fed well into that six month window.
Now investors will be buying stocks based on the expectations of rates rising quickly if the economics continue to be strong. Any potential rate hike will be offset by an increase in earnings IF the recovery continues. In the early stages of an economic recovery rates do rise and investors are used to that model. The big difference here is that they could rise much earlier and much quicker than expected just a week ago.
I know this kind of economic double talk is boring and many readers just skip these paragraphs. I wish I could too but we need to know what may be in front of us. The Dow drop on Friday of -47 points is meaningless. More critical to me is the lack of an advance for the week. We tested the 52-week highs at 9900 twice during the week but the market seems very heavy. I know "seems" is a vague word but that is what I see. The internals are still strong with 1066 new 52-week highs on Friday. Definitely no weakness there. Advancers beat decliners and volume was decent. There is nothing to reach out and touch but the upward momentum is definitely slowing.
I got a kick out of one reporter on CNBC Friday night saying the market was not moving higher because there was no catalyst to give investors a reason to buy. Give me a break! If you were an investor looking for a reason to buy stocks the last week was a banner week full of catalysts. If anything there were too many buy signals and there are simply no buyers left. Another problem is still the mutual funds. In the last week $4.4 billion was withdrawn from Putman with as much as $10 billion withdrawn from the other top five funds under investigation. This is a huge amount of money to leave the market in only once week. Considering there was a $15B withdrawal I think the market did rather well.
Other factors weighed on the markets for the week with 20+ soldiers killed in Iraq and drawing lots of attention and negative press. A post office in Washington tested positive for Anthrax and 11 post offices were closed for further tests. Homeland Security said Al Queda was planning to use cargo planes to attack the U.S. and "specific and credible" threats prompted embassy closings for the weekend. Taking all these items into consideration it is a wonder the Dow was not down -247 instead of just -47.
For those expecting a bullish week to start November and historically the two best months of the year then you may have been disappointed. We closed almost exactly where we started with tech stocks the only winners. If you are looking for a week with catalysts to inspire traders it will not be next week. There are only two major reports on Monday and then nothing of importance until Friday. The two reports on Monday are the Richmond Fed and Kansas City Fed surveys. These chart manufacturing growth and outlook for those regions and are seen as proxies for the rest of the country. They are expected to show growth but nothing exciting. This leaves traders with no news for four days. Considering the fade on fantastic news Friday this may not be a bad thing.
Technically the Dow pulled back from the highs to rest on support at 9800 which had been resistance since early October. You cannot call that a bad performance. Since early October we have been trading in a narrow range with only a slight uptrend as we waded through earnings. With earnings and economics over for the time being the next level Dow support at 9700 could be tested soon. The Dow did not make any attempt to touch 10,000 and several analysts have expressed doubt we will see it before seeing 9500 again.
The Nasdaq has a better uptrend in place and came very close to 2000. The drop at the close only brought it back to uptrend support at 1970 and it was quickly bought. The continuing good news on semiconductor stocks has put a floor under techs that will be difficult to break. Add in the CSCO news that IT spending is starting to increase and all the feeder stocks that supply Cisco saw a huge pop. It was a good week for techs despite the Wednesday profit taking. The Nasdaq is well above strong resistance at 1950 and it would take a serious sentiment change to move it below even stronger support at 1900.
Can these indexes reach those support points at 9700/1900? Sure, if investors decide that potential rate hikes outweigh the potential gains created by an exploding economy. While I had been expecting a stronger correction soon I have just about decided that changing conditions have negated that possibility. My capitulation is a sure sign that a drop is near. The VXO remains trapped in the 17.50 range despite the end of day sell off. The total lack of fear in the market is the only thing that keeps me hanging on to an outlook that is filled with caution. I am not going into all the reasoning again but there is reason to be concerned.
Bonds will be under pressure next week with $57 billion coming to market to finance the deficit. The dollar got crushed on the employment numbers and there is going to be more stress next week. The economics and potential rate changes will cause currency fluctuation until traders the world over balance their risk profiles to the new paradigm.
The biggest news of the week was actually the Greenspan
warning shot about the deficit and the coming Social
Security problem. According to Greenspan the first baby
boomer retirees will begin retiring in five years and
accelerate sharply from there. He said the Social Security
and Medicare benefits promised under current law for these
retirees CANNOT be financed with current tax rates. No
surprise there since this warning has been present for the
last 20 years. The fact that Greenspan chose to resurrect
it in a major speech at this time in the political cycle
almost seemed to be a free shot a the current administration.
He warned that this will set into motion an "unsustainable
dynamic" that could have "notable destabilizing effects on
the economy." He said "tax rate increases of sufficient
dimension to deal with our looming fiscal problems pose
significant risks to economic growth and the revenue base."
In other words he sees a real crisis coming that simply
raising taxes will not cure and it starts in 2008. These
comments were glossed over in reports about the speech
but I think they are the most important paragraphs.
I attended a financial seminar sponsored by Citigroup a couple months ago and they were projecting the same thing. Their outlook was for a massive tax increase in early 2005 once the elections were over. There are various reasons that I have explained here in the past. The reason I bring this up again is to remind readers to plan their long term investing wisely and watch out for these significant market challenges ahead. The mainline press conveniently failed to discuss these points in the Greenspan speech.
We have a very flat economic week ahead and no material earnings other than Dell on Thursday. There is very little to capture investor attention and the mutual fund scandal will probably return to the top of the news sound bites. If the cash outflows continue from the top funds in trouble then that will impact the market. The squeeze is on for those in the headlines but the money will eventually find its way back to the market in another fund. This 2-3 week cycle time should help slow any market gains. In summary, the market has some more consolidation work to do before moving higher and that consolidation should continue next week. We are more than likely going to remain trapped in our current range from 9600-9900. The excitement has faded and to twist the reporters comments slightly, there is no catalyst on the horizon to rekindle that excitement. After over eating a big thanksgiving dinner the urge to nap is strong and after the economic overdose this week the markets need to take that nap.
Enter Very Passively, Exit Very Aggressively!
A reader sent me this letter to his senator and I thought it was interesting and you might enjoy it. Good research and a thought provoking conclusion.