Lame duck Alan Greenspan took his market-crashing act on the road on Friday and comments made in Germany dropped our markets for the first weekly loss in four weeks. Alan is in his last term as Fed head and has recently been taking shots at the current status quo and generally rocking the economic boat. As a short timer he has adopted a Chicken Little attitude about things as diverse as Social Security, trade imbalances, deficits and hedge funds. As his term fades he is setting up his "I told you so" points for future use. Friday was a prime example.
SPX Chart - Weekly
Friday morning Greenspan warned during a speech in Germany that the size of the U.S. current-account deficit should produce a diminished appetite for buying U.S. debt. While this is not news the strong warning while out of the U.S. and just in front of the G20 meeting in Berlin set off alarms for traders. With China and Japan currently holding the largest amount of all U.S. debt at 39% and another 10% liberally dispersed among other nations the blunt warning to those holders was a serious shock. That is like telling a potential house buyer that your house is over valued at the current price. Odds are good he will offer you less than he would have or immediately walk away. The fear is that those countries who fund our spending by buying our debt may rethink that concept if the chief banker thinks it is over priced and high risk.
Should the demand for our debt decline then interest rates would have to rise in order to convince them to take the risk. Higher rates cost the U.S. more money and we are not talking chump change. With the deficit reportedly near $1 trillion for 2005 just a +1% rise in rates will cost a lot of money over the life of the notes. The House voted Thursday to raise the debt ceiling by +$800 billion to $8.2 trillion for 2005. Rates could easily rise much more than 1% given the Fed policy at present and no relief in sight to balance the budget. An even worse scenario would appear should those foreign holders of 50% of our debt decide to reduce positions and begin dumping that debt on the open market. Rates would not just rise but immediately skyrocket and the impact on the economy would be very severe.
The falling dollar is worrisome at best and while it will help our trade balance it needs to come down at a controlled rate not a free fall. These comments by Alan shocked traders and a few raced to the exits. Currency fluctuations and implosions can appear out of nowhere and tank markets at will. Because 99% of equity traders have no clue how currencies affect equities or economies the retail traders are always caught off guard. Just when the sunshine seems brightest a lightning bolt from the blue shocks markets into cardiac arrest.
The comments from Greenspan went on to suggest that the Fed may have to escalate their rate hike process to adjust to the continued dollar drop. That was just what markets on the verge of a breakout needed to hear. Faster rate hikes ahead could mean multiple tightenings, larger hikes and a rate parity around 6% instead of the current 3% target.
With the Euro holding above 1.30 to the dollar and just fractions below the all time high set on Thursday the G20 meeting is not expected to fix the problem. In fact it could escalate the problem depending on the mood of the attendees in light of the Greenspan comments. The dollar index hit another multiyear low on Friday and Gold hit another 16 year high at $448.50. The concern about the dollar drop as well as some minor supply disruptions sent oil soaring back to close just under $49 and a +2.60 gain for the day. The 100-day average at 45.75 never broke as support and we could be at the beginning of another oil price cycle but it will take more than a one day spike to confirm.
Dollar Index Chart
Crude Oil Chart
The twin deficits of budget and trade are keeping our rates artificially low according to some but others are more concerned. Doug Kass of Seabreeze Partners pointed out that the Leading Indicators this week have fallen for the fifth consecutive month and this is the first time in 45 years that it has happened outside of a recession. He pointed to the strong signs of a slowing consumer and corporate earnings still being met more on cost savings than revenue increases.
The bulls view that slowdown as due to the weight of a highly contentious election and the record high oil prices. There will always be a difference of opinion between stock bulls and economic bears but having Alan weigh in on the side of the bears is not good for stocks. Greenspan's speech turned into a tirade against the U.S. where he verbally questioned the wisdom of other countries in allowing the U.S. to finance such a large deficit at more than 5% of GDP. He went so far as to caution that payments on large debt balances would eventually become burdensome to the U.S. and countries concentrating their assets in U.S. debt could be at risk.
Can you believe this? Sounds like a dad lecturing a teenager about the evils of high car payments and their inability to pay in front of the loan officer deciding whether or not to make the loan. Later he literally told them that they should be demanding higher interest rates to offset the increasing risk. He basically said if they would buy less debt and demand higher rates the U.S. would be forced to import less and live on a budget. While I agree with the long term concept of balancing trade and living on a budget I don't believe Greenspan should go to the G20 and tell them to cut off our life support.
While it is too early to tell if foreign banks will cut our allowance the impact of Greenspan's verbal tongue lashing was immediate. The markets imploded at the open and never looked back. None of the major indexes ever made a higher high for the entire day. It started out as an express elevator to the basement from the 100th floor and ended up pausing to let a few passengers off on the last several levels. The end result was a Dow that failed at support at 10550, 10500 and 10475 to slide to a stop at 10450 with only a minimal bout of short covering at the close. Should the slide continue on Monday there is substantial support from 10375 to 10400 and the likely bottom of any further selling. As much as everybody wanted the Dow to break 10600 it was exactly the right spot for a failure to occur. The Greenspan comments were just the extra push the bulls needed to take profits. By pausing to rest at 10600 the Dow will be stronger if it decides to tackle 10750 and the highs for the year.
The Nasdaq gave up 2100 after only two days at that altitude and spent most of the afternoon fighting to cling to 2075. That battle was lost just before the close with the index going out at 2071. The equivalent support to Dow 10400 is Nasdaq 2040 and well below our closing level.
The Nasdaq drop was accelerated by a chip downgrade by Goldman Sachs. The broker said there was more pain ahead for chips due to over capacity and lack of demand. Smith Barney immediately fired back that the worst was over and chips should be bought on weakness ahead of a rebound in 2005. Intel CEO Craig Barrett again said he sees chip demand increasing in 2005 and defended his planned capacity increases. Ultimately the markets listened to Goldman Sachs and sold chips faster than a peanut vendor at a ball game. The SOX had closed at a breakout high of 445 on Thursday and that move was completely erased with a drop to 432 by the close. It is still above downtrend resistance but it was a nasty retracement given the recent recovery talk.
The Russell was hit especially hard with a drop from 622 to 613 but it was not as clear intraday. The morning drop was vertical but was over by 10:00. The Russell held 615 for the next five hours with a minor upward bias but a sell program just before the close completed the drop. The Russell has rebounded +22% from the low for the year at 516 set on August 13th. +12% of that bounce had been from the 562 low made on Oct-20th to the 628 high on Wednesday. The Russell was definitely due for a rest and the sudden appearance of Darth Greenspan Vader shook up those investors and they fled the scene. Considering the amount of profit on the table a -15 point drop from the Wednesday highs to the Friday close was only a hiccup.
The SPX traded in a range from 1175-1185 for most of the week with the intraday spike on Wednesday the only real deviation. On Friday the opening drop knocked us back below 1175 and we never recovered. You might remember the 1175 level was critical on the advance as the 2002 resistance high that held for all of 2002. Due to the strength of the rally it only took two days to squeeze by on the way up. Now that it is five points above us again and the race to catch the rally train has slowed it might be a little harder to move back over that level. The SPX held 1170 at the close. That level did not have any significance on the way up and I think the sellers just ran out of stock on Friday. Remember we have had a complete lack of sellers for three weeks. There is nothing to suggest that conditions have changed. The really strong support is waiting at 1165 and it is strong enough to blunt anything but a concentrated bout of real selling on high volume.
The most accurate measure of the market is the Wilshire 5000 and it lost -127 on Friday to close at 11483. The Wilshire has very strong support at 10375 and very strong resistance at 10620. This suggests we could see continued selling on Monday to retest the 10400 level but that retest should hold.
For next week the historical trend is normally bullish. Of course that assumes the Grinch that stole Christmas is not running around Germany passing out business cards for collection agents in case of payment default by the U.S. When asked later if his position meant the Fed might raise rates more than the market expected he replied, "rising rates has been advertised for so long that anyone not currently hedged is desirous of losing money." In English, yes, you can bet we are going to continue to raise rates. The Fed fund futures are predicting a 91% chance of a hike in December and an 80+% chance of a hike in February.
What happens next week is going to be dictated by what happens at the open on Monday. The odds are very good there are quite a few traders and mutual funds that are celebrating this weekend. The Friday drop took a lot of excitement out of prices without a material drop in the indexes. Biggest hit were the financials, home builders and any interest sensitive stock. Some of that money rotated back into oil and energy stocks despite any material reason for the price spike. Iraq production was slowed by weather and some terrorist attacks but nothing new there. The strike in Nigeria was cancelled again. That has been on and off so many times it resembles the Three Stooges caught in a perpetually revolving door. Russia says it will auction off assets of Yukos over the next 30 days to pay for back taxes but there is not expected to be any disruption in production. Oil production has mostly returned to normal from the Gulf and there has been a steady build in supplies to a more normal level. I see the smoke in the price hike but I don't see the fire that caused it. I suspect more than anything it was related to option expiration and short covering.
That brings us back to equities once again and while there is economic unrest in the financial community from Greenspan's comments I see no real reason for the selling in equities to continue. I believe the knee jerk reaction triggered additional profit taking sell stops. Add in option expiration and mass confusion was the result.
There are no material economic reports on Monday and volume may start to slow for the holiday week. Money is still flowing into the markets at an average of $1.2B per day since Nov-1st. $8.5B flowed in over the last eight days. Sucking up that $8.5 billion was over $6.5 billion in new offerings over just the last three days as well as money pouring into the new ETF for Gold. Over $500 million poured into the GLD shares on Friday. The very strong new offering calendar may have blunted the dip buying on Friday. PLAY priced 6.25 million shares at $17 Thursday night and the stock soared to $26.25 in its first day of trading on Friday. Over ten million shares traded with only six million priced. Who says day trading died?
Google insiders filed with the SEC late Friday to sell 16.6 million shares. 7.2 million each for Larry Page and Sergey Brin and 2.2 million shares for CEO Eric Schmidt. Separately Kleiner Perkins, a venture capital firm that helped Google raise capital filed to sell 5.78 million shares. Kleiner Perkins bought the shares for 49 cents each in the early stages of Google financing. Definitely a windfall and I definitely don't fault them for selling. It is not real money until it is converted to cash.
We are just over a week away from a massive injection of liquidity into the market and everybody should be planning for the bounce. On December 2nd Microsoft will pay out $32 billion in the form of a $3 per share dividend. According to the pencil pushers who analyze these things at least 40% will be put back into the market within a week. That 40% ($12.8 billion) is the portion owned by funds that automatically reinvest all dividends. Another 20% will hit the market over the next week from those funds that are discretionary in reinvestment. $3 billion will go to Gates and he is giving it to charity. That leaves $9 billion that will be paid to individual shareholders. Much of that will already be spent at the mall on plastic the weekend after Thanksgiving. Some will be reinvested in stock but estimates are for less than 50%. Using just the fund numbers at $19 billion going back into stocks over a two week period between Dec-2nd and 17th the market should be floating on some major liquidity. That $19 billion is in addition to the normal cash inflows during December. It should be a merry Christmas for everyone.
Unfortunately we still have to get past Monday. If the Friday drop was just knee jerk reaction, sell stops and option expiration then Monday should be a consolidation day. Bulls will stagger to their feet, look cautiously around and start to move back up the hill before the close of business. Remember, funds will want to be in the market before that big liquidity balloon hits on Dec-2nd. This should cause them to buy the dip as well but I am sure there will be a lot of consternation at the open on Monday. Was the drop on real worry or just an imagined problem? Each fund will want somebody else to make the first buy and everybody will be looking for confirmation we are not going lower. There will be opening volatility from option settlement and we need those ripples to fade before wading back into the water. Those traders waking up with a hole in their account from being called away or suddenly finding stock in their account they did not expect will rush to adjust positions back to level. If a trader sold 10 contracts of the $55 puts on TASR thinking he would capture the $4 premium from out of the money options last week then you may be surprised to find 1000 shares of TASR in your account on Monday. That would set you back about $52,000 and crimp your trading style until you unloaded that stock. TASR dropped -$6 on Friday. Moral to that story is always have stops in place. That is the kind of option settlement adjustment that normally keeps OpEx Mondays from being too directional.
If next week does not finish higher I would be surprised. The last five years have seen some major moves before and after Thanksgiving with Friday having the better chance of a positive finish than the beginning of the week. In 2002 the Tuesday before saw a -173 point drop and Wednesday saw a +255 point gain. Volatility has been strong and we are coming out of a string of negative days early in the week that started in 1998. With the bear market behind us we are due for a positive bounce. Last year the week before Thanksgiving was terrible with the Dow losing about -250 points to a Friday close at 9628. Beginning on Monday with a +125 point gain the holiday week was bullish and it was also the beginning of the strongest eight weeks of the year with the Dow topping out at 10701 on Jan-26th. The +1000 point romp was the finishing sprint to a market that had already rebounded from the March lows at 7416. After tacking on +2200 points in the prior eight months the November dip set the stage for another +1000 points with hardly a down day for the rest of the year. Will that happen in 2004? Nobody knows but the Friday drop came at exactly the right time to clear the profit stops and let new money back into the game.
Dow Chart - Thanksgiving 2003
Personally I am looking forward to the next six weeks and I hope we see a repeat of 2003. All the bad news is behind us and according to most analysts there are good times ahead. Maybe not boom times but a good environment for good stocks to prosper. I believe this lure of a promising future will continue to attract money into the market until year end. Once past the year-end is where the mystery begins again. Until then continue to buy the dips above Dow 10350, SPX 1160. If those levels break then all bets are off and Santa may not be coming to the markets this year.
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Sell Too Soon!