Signs of economic weakness reappear and sellers edged out buyers by slightly more than 2:1. However, while the markets took profits they still held their ground. Bonds soared as the fear of the Fed eased and yields hit new lows for the month. Is there a change in the wind?
Dow Chart - Short Term
The big number out on Friday was of course the Jobs report and traders were expecting a big surprise. Unfortunately the surprise they got was not the one they expected. The official consensus was for an increase of +140,000 jobs and the whisper number was as high as +250,000. On CNBC Thursday night Kudlow was positively giddy about the potential for a 250K number and pressing all his guests to agree with him. This was only the culmination of a week of bullish comments by analysts and not an isolated incident. This set traders up for a disappointment as I discussed on Thursday night. That is exactly what they got. The actual number was for a gain of only +57,000 jobs. While it was still a gain and the fourth month of gains the market did not like it. How quickly traders can become spoiled when several consecutive reports show improvement. Even the upward revision from 126,000 to 137,000 for October failed to impress when the number for this month was only about 1/3 of the official estimates. It also did not help that September was revised down from 125,000 to only 99,000, a drop of -26,000 jobs. If you don't like this months numbers stick around they may change several times over the next three months.
Despite the minor gain in jobs the actual number of unemployed dropped by -105,000 to 8.674 million. This dropped the rate of unemployment to 5.9% and an eight month low. How can this be? First the unemployment rate is actually derived from a different survey that is considered less accurate than the payroll survey. Encouraging? Also, it is a known fact that many workers are giving up on the job hunt when the benefits expire. Two income families decide to make it on one and the unemployed partner stays home to live on less or retire early. The unemployment rate did not go down because many people suddenly found jobs.
The analysts were more disappointed about the +57K number because they thought with the ISM, GDP, Jobless Claims and the other stellar economic reports of late that they had a real chance to actually have a blowout. It takes +150,000 jobs per month just to breakeven with additions to the workforce. Workers coming out of school, immigrants and decisions by single income families to become dual income adds 150,000 people to the available workforce each month. We have been running at a negative job rate so long, several years in fact, that analysts felt all the stars had lined up in our favor to break the trend. When it weakened instead they immediately started grabbing for the silver lining.
Temporary employment was up, the work week was longer, the productivity was exploding and so on. Yes, but most sectors showed decreases in jobs for the month with the exception of construction payrolls. Even financial services lost jobs as the mortgage refi industry implodes. Manufacturing jobs fell -17,000 for the month and wage growth only rose by one cent per hour. It has been decelerating for a year and could go negative soon.
Not all the news was bad. This was the fourth consecutive month that jobs were created. While the gain in jobs was modest it is exactly what had been expected for the last year, slow jobs growth until the recovery had some history behind it. The only history we have is a blowout 3Q that was entirely due to the tax rebates and tax cuts. That put cash in consumers hands and they spent it. Once that cash was spent Oct and Nov have been retail wastelands. That does not mean the recovery stopped. It just means than the injection of speed we had in the 3Q has worn off and we are right back in the slow growth we have seen all year.
This slow growth mode as evidenced from the jobs has one really strong benefit. The Fed is now likely on hold until the 1Q of 2005. Yes, 2005. The Fed funds futures were looking for a 50% chance of a 25 point rate hike in April before today. After today that chance has dropped to only 25%. With retail in the tank and airlines seeing a drop in bookings the Fed is not going to want to trip up the struggling recovery with a preemptive rate hike. The strong drop in jobs from the prior month actually gave the Fed a free pass for the 1Q. Since the economy is normally slow over the 2Q they should not be pressed to hike rates then either. 2004 is also an election year and hell would freeze over before they hike in the 3Q just before the election. That political gift to the democrats simply will not happen in a republican administration. That makes December the first free meeting and the Fed rarely hikes rates in December to spoil holiday sentiment. What this does mean is we can guarantee a rate hike, probably several, in the 1Q of 2005. I have said before that should Bush be reelected he will probably be riding the crest of the current liquidity wave and the results of the $165 billion in tax cuts/rebates in 1Q 2004. That wave will give the recovery legs that will race into the election but in 2005 he will cut those legs out from under the economy with large tax hike. He has to raise taxes once the economy is firing on all cylinders. Otherwise the country will be broke by 2008. Literally. Looks like I got ahead of myself but the main point is the Fed is likely on hold through 2004 with the only risk a minor hike in April. Want proof? Look at the drop in yields on the Ten Year note on Friday. It was the biggest one-day drop since Jan-2002.
Ten Year Note Yield Chart
Other good news included a jump in the Factory Orders by +2.2% in October, which was slightly better than consensus. The markets actually dismissed this news as well because they had expected more with the whisper number in the +3% range. Blowout numbers like the PMI last week have spoiled them to thinking that all future numbers will do the same and while the numbers today were good they were just not good enough for analysts. This was also an October number and yesterday's news.
The markets were already looking weak on the Intel and Jet Blue news and the Jobs Report sealed the deal. They gapped down at the open but surprisingly enough not significantly. The Dow hit -40 and held at 9880 support. The Nasdaq took it harder due to Intel and gapped down -25 but also held. They held those levels despite negative internals until after 1:PM but the fear of darkness finally took hold with a major sell program supplying the push over the cliff. It was a short drop and the Dow came to rest on strong support at 9850, Nasdaq 1940. They spent the last hour fighting off all sellers but were only able to hold their ground and not gain any.
The major problem was the Intel news. The chip sector had been at 52-week highs on Wednesday with the SOX at 535 but the Intel news coupled with the Nasdaq touch of 2000 combined to induce some serious profit taking. The SOX closed at 499 for a -6.5% drop in three days. This is very strong support and this support helped hold the Nasdaq at 1940.
Also helping push the indexes lower were the retailers. Sears for instance has dropped nearly -$7 in three days (-12%) and there appears to be no letup in sight. FD joined the party with a -5.4% drop. The problem here is the weak retail sales and lack of any positive guidance for December. With more than 50% of chains missing estimates for November and many expressing concerns about December there are no bargain shoppers picking up these blue light stock specials.
The Jet Blue warning rippled across the airline sector with all the minor carriers looking for a flat spot to land. JBLU lost -$5.52 (-17.59%) and that was on top of a -$6 slide in the prior three days. LUV was also cut on Thursday and they dropped another -6% to $15.50 from their $18.50 high earlier in the week. The majors dropped less but the entire sector was under pressure. The XAL broke support at 60 and appears headed lower. This should pressure the Transportation Index and that will continue to drag on the Dow.
Airline Index Chart
The Russell-2000 remained under pressure with another drop of -5.14 and a close at 539. This was the fourth consecutive day of declines but there is still room to fall. Real support is in the 520-526 range and I would not be surprised to see this tested next week. Funds are selling but not yet in volume.
Russell 2000 Chart
The fund scandal continues to weigh on the markets but the flight out of the Putman funds may have slowed. Putman said they had $32 billion in net outflows in November. The Strong funds had -$2 billion in outflows in November as the founder put the company up for sale. Despite these problems AMG Data said that over the last three months there was a net inflow to all equity funds of +$57 billion. The three-month period nearly equaled the record high in the 1Q of 2000 and the market top. Makes you wonder what is in store for us in the near future if the bullish money flow is back to bubble levels.
About the only thing investors did not have to worry about on Friday was terrorists. The news services were nearly silent about weekend warnings and the talking heads were more concerned about the Jobs report than the terror reports. There were more bombings, one very serious, but the markets appeared to ignore them.
Next week should be critical for the markets. We start a new round of economic reports with the Kansas City Fed Survey on Monday, FOMC Meeting and Richmond Fed Survey on Tuesday and PPI and Sentiment on Friday. There is also a sprinkling of other filler reports throughout the week. The focus will be the FOMC meeting although the outcome is assumed to be neutral. They will be looking for the deletion of the "considerable period" comment although it has already been discounted away. Should it stay there will be a strong relief rally as that would officially put the Fed on hold for the foreseeable future. If it disappears I think the markets will blip for a few minutes and then go back to business as usual.
More important than the FOMC meeting is the critical support levels for last week. The Dow closed right above 9850 which is very critical support. This has been support all week and a failure of that level should see an immediate drop to 9750 with a risk to 9600-9650. This should not be a surprise to anyone who has been reading my recent articles. The 50 DMA is 9711 and that uptrend support has held since March. It will not hold forever but until it fails convincingly traders will continue to buy the dip at that level.
The Nasdaq also closed at support for the week at 1940 and the 50 DMA at 1920 should provide a pause if 1940 fails. Worst case support for next week should be 1880-1890. This would be a major risk to the uptrend and a break below 1880 could set off a cascade sales event. I do not expect it next week.
What I expect is an opening bounce on Monday and then more weakness before the week is out. I think the Dow will see 9700-9750 and then firm up as the dip buyers hit that test of the 50 DMA. In addition to the FOMC meeting and the various economic reports we should see some more earnings warnings so there will be no shortage of news to move the markets.
The main thing investors should remember about the next three weeks is that they are NOT critical. We may see a Santa rally begin around the 15th or we may not. We could attempt a retest of 10,000 again or 9500. The odds are very good that we will go nowhere. There is a lot of bullish sentiment and the closer we get to the holidays the stronger it will get. There is also a lot of overhead supply so breaking through to new highs would be tough. This should mean we will remain range bound between now and year end.
What "investors" should focus on is the expected drop in January. We will devote more commentary to that as we get closer. Over the last six years January has seen a drop from the highs of between -550 and -1050 points. This is due to hedge funds and portfolio managers waiting to take profits until the new year to push the tax consequences farther into the future. This is a recent trend and one that has accelerated as the consecutive string gets longer. Experienced investors have been able to play these trends profitably. We have devised our current year-end renewal special to allow readers to profit from this. Be sure to read about it below this commentary.
For next week I would suggest only aggressive traders need apply. It is likely to be choppy and news driven. For conservative traders I would watch the Dow 50 DMA and use that as your entry point for any potential Santa Rally. That rally when it occurs tends to begin around the 15th and run into the end of the year. Be prepared for it but don't count on it. The huge profits by fund managers are just waiting to be harvested and the odds are good some funds will begin lightening the load soon and using any Santa rally to offset their sales. This is a good period to be conservative and get ready for 2004. If you have an IRA I would use the holidays to decide what stocks you want to buy on the January dip. I would use the rest of December to decide what stocks you want to sell before that dip begins. Plan your trades wisely and trade your plan.
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