The market celebrated the end of convention event risk with a yawn and the concern immediately shifted to the lower than expected GDP. The critical convention event risk expired with no more excitement than a week old newspaper.
Dow Chart - Daily
Nasdaq Chart - Daily
NYSE Composite Chart ($NYA.x)
The big news for the morning was not the end of the convention risk but the unexpected drop in the Q2 GDP to +3.0% from +4.5% in Q1 was well below estimates of +3.8% growth. This was the lowest level for GDP since the +1.9% in Q1 of 2003. The biggest component drop was in personal consumption which fell from +4.1% in Q1 to only +1.0% in Q2. This was a major drop and confirms the retail weakness we have been hearing about for a couple months. Overall the GDP is still up +4.8% over the last four quarters but that is mostly due to the +7.4% jump in Q3-2003 as a result of the 2003 tax rebate. The minor rise in consumer spending was the smallest gain in over three years.
While the GDP was a disaster the PMI was a blowout. The Business Barometer headline number was 64.7 compared to 56.4 in June. This did not completely reverse the drop in June from 68.0 in May but it does bring the report back in line with the prior two months. The Production component soared to 69.5 from 53.9 and New Orders rose to 68.7 from 56.8. Backlogs rose +6.5 to 60.2. The only component with a strong decline was employment which fell to 45.6 from 53.6. That was the worst labor reading since June-2003. Most notable was the drop in inflation with Prices Paid falling to 77.6 from 84.5. This was the first drop in PP since February.
Also adding to the positive economic picture was the NAPM-NY which rose to 302.5 in July and well over the 290.9 in June. This is a multi month high and shows business conditions are still improving. Non manufacturing activity jumped +31% to 71 from 58.0. Current conditions jumped to 72.3 from 57.6 but the six-month outlook exploded to 78.5 from 60.
Strong economics like the PMI and NY-NAPM along with the Philly Fed and Empire State survey suggests the ISM on Monday could see a strong upside surprise. The challenge is whether the rebound actually occurred in July or just the beginning of the rebound. The consensus estimates are for a headline number of 62.0 and right in line with the last four month average of 62.2. The recent high was 63.6 in January and we have seen numbers near 61 twice in Feb and June. A number over 63.0 would be seen as a very strong confirmation the economic soft patch is behind us. The markets should act positively to any strong number.
The GDP sinking to +3.0% growth for the quarter and the uptick in the regional indexes for June/July suggests May was the weak link that dragged down the GDP. The best news was the falling inflation levels. With a soft GDP and inflation levels coming off their highs despite high energy prices the Fed should be ecstatic. The Fed meeting on August 10th is still showing the possibility of a rate hike but there is no possibility of a 50 point hike as there was in the past. The current Fed Funds Futures are pricing in a 25 point hike in August, November and December and would raise the target rate to 2.0% by year end. I believe the Fed will raise rates in August because to not raise them would raise questions about what does the Fed know that we don't. Since the hike is already priced in the Fed will get a free pass on this one.
The final reading on the July Consumer Sentiment came in at 96.7, +2.0 over June's 95.6 and slightly over estimates. The dip in gas prices added to the slight rise in sentiment but with prices rising again we could see sentiment sink once that $2.00 per gallon rate is back to haunt us.
Oil rose to an all time high at $43.85 and spiked well over previous levels. The reasoning analysts are giving is the potential for terrorist attacks causing a real slow down in deliveries. OPEC is reportedly pumping every barrel they can and well over the stated production quotas. Meanwhile the demand for oil is growing at a 24 year high. This means any production stoppage could send prices soaring even farther. The rumored target is Saudi Arabia where the regime is under attack and they are a major producer of high quality oil. Terror attacks have grown in intensity and frequency and the oil infrastructure is reportedly too wide spread to protect completely. Traders are fighting rumors that the production/transportation facilities could be attacked just before our elections in an effort to drive prices significantly higher and provide a voter backlash from high gas prices. Granted this is all just speculation but as you can see by the price there is worry. Oil supplies are actually rising in the U.S. and some traders feel the price spike will end badly.
What was really surprising on Friday was the disconnect of the stock market from the oil price. Recently we have seen a strong divergence in prices when oil rose, stocks fell. This disconnect could be the symptom of an impending move higher in stocks. We saw support levels remain rock solid at 10100 on the Dow and 1098 on the SPX. The S&P futures closed at the high of the day at 1103.75.
Unfortunately the market action on Friday was far from predictable. The price action on my charts was more like child's crayon scratching than a recognizable pattern. We tested highs and lows of the various support/resistance ranges almost at will with no directional trend. The strongest move of the day came just before the close when the Dow and SPX rebounded off their lows and returned to their highs in just the last 25 min of trading. Techs, which had been stronger turned weaker in the afternoon in stark divergence to the action in the Dow and SPX.
The Dow traded in a 64-point range from 10086 to 10150. The 10100 support was rock solid and 10150 was equally solid resistance. We made the round trip to both levels multiple times over the last two days and the battle seems far from over.
The Nasdaq traded in a narrow 20 point range just under 1900 and was supported by the SOX (+1.27%) and the Russell which traded over its 550 resistance high several times. The only trend was sideways and that was barely discernable.
The easiest method of illustrating the abrupt swings in the market is to show an intraday chart of the Advance/Decline line. This chart shows alternating buy sell programs almost constantly throughout the entire day with major swings late in the afternoon. Those swings in the afternoon were +/- 700 issues on an alternating basis. Very difficult to trade when alternating buy/sell programs are running rampant. This is good news because volatility means change is in the wind.
I have been expecting a post convention rebound and I have to admit Friday was very frustrating. I kept expecting every rebound to break that overhead resistance and begin to move higher in anticipation of next week. Unfortunately that strong move up did not appear until the close when the futures moved to the high of the day.
There were multiple reasons for the lack of momentum with the primary ones being the very low GDP and the nearly $44 oil. There also appeared to be a sell the news crowd that came to the market this morning also looking for a rally to sell into. The good news was the strong underlying bid at 10100 on the Dow and 1098 on the SPX. Buyers took a lot of shots but managed to hold the line. I may have been expecting too much for a summer Friday with barely over three billion shares traded but I have not changed my tune.
Despite the choppy week and some new lows all around the indexes did manage to finish positive and at the highs for the week. It was the first positive week for the Dow and SPX since June-18th. The Dow gained +177 and the Nasdaq +38. Not great numbers but still a reversal of the trend. I view the strong underlying bid on Friday as proof that sellers are beginning to lose their grip on the market. With the S&P futures closing at a two week high and well over 1100 at 1103.75 it suggests we could see a very different market on Monday.
I still believe that SPX 1100 resistance will break to the upside despite multiple failures at the 1102 level on Friday. Part of my reasoning is the trend for the last 11 election year cycles for the markets to rebound the first week of August. Secondarily we are still very oversold given the positive earnings we are seeing. I believe any rally will eventually fail but that is another story for another day. Treat any continued rebound as a trading rally only and keep your stops in place.
With the convention over one of our fear factors has been put to rest. Kerry is still in a dead heat with Bush but his pep rally is over. I am sure he hoped to add some points in the polls but the latest survey showed Bush adding +2 points on Friday. The Kerry platform has been publicized and the critics are coming out the woodwork. Drug companies are under attack and price controls and green power are the hot topics.
On the Republican side the Budget Office released the expected budget deficit today at -$445 billion. While that is a record deficit it is still not complete. The budget was offset by a +$155 billion social security surplus. Considering the state of the SS system that money should remain in the trust fund for future use instead if used to pay bills. The war in Iraq was not included and will be brought up as a supplemental item in the spring and is expected to be $50 billion. Add those together and we have a real budget deficit in the $650 billion range. This is why foreign investors are fleeing our markets with net withdrawals for the last three months. They believe the soaring deficit will require desperate measures that could handicap our economy and our markets.
To be fair that deficit is the result of the post Y2K recession that began in early 2000, the 9/11 attack, massive expenditures for homeland defense and the huge tax rebates that helped to spark the economy in 2003. There are pros and cons on both sides but the main point I want to make is the market is watching the polls. The drop over the last three weeks could have been partly due to the convention event risk but not risks from terrorists. Had the convention produce a ground swell of support for some new program of price controls, budget cuts and cancellation of last years tax cuts then the market would have reacted negatively to any Kerry gain in the polls. With the convention over and no new agenda the danger, in both contexts, seems to have passed. The market is free to discount the race with the Republican pep rally still ahead.
In stock news of note Intel announced a delay in the release of the new 4ghz Pentium 4 processor until the first quarter. Giving confusing reasons in English that would make Greenspan proud the company deftly avoided saying that by pushing the chip one quarter farther out they could dump their high inventory of older chips during the Q4 holiday sales cycle. Intel management is not stupid and they realized that by delaying the long awaited chip all the computers built in the 4Q would have to be built with the older chips. Does not take a rocket scientist to see the reasoning here.
I ended last Sunday's article with instructions to look for good stocks over the next couple days that were beaten down with the market and then expect an end of week rebound. Monday was the low for the week and you got a second chance on Wednesday. The Dow finished +224 points off its lows for the week and the Nasdaq +54. If you followed my instructions you probably did well.
For Monday the Thursday night instructions have not changed. Remain long over SPX 1100 and short/flat below that level. Hopefully we will get a stronger than expected ISM and we will be off to the races. As always, just like the GDP on Friday, there is the potential for a negative surprise so wait for the announcement volatility to pass before entering new positions.
Enter Very Passively, Exit Very Aggressively!