Companies are in a shopping mood this season and today was a banner day for deals. Symantec and Veritas, JNJ and Guidant, Nobel Energy and Patina were all caught up in the holiday shopping excitement. Unfortunately traders said bah-humbug and dumped stocks for several reasons. Some days even the best news falls on deaf ears.
Bad news was more important to investors today and there was plenty of it. Suddenly new home construction hit a wall and starts fell to an annualized rate of 1.77 million. This was a -13% drop over October's 2.04 million rate and the largest drop in eleven years. The drop suggests builders are becoming concerned about an overabundance of future supply. We don't know if that was based on slowing sales or just an anticipation of slowing sales given the potential for interest rate hikes into 2005. Builders are continuing to exceed earnings estimates for every quarter and sales have also been strong. By lowering inventory levels they can keep prices high and not get into a price war. Housing permits also fell to 1.988 mil from 2.018 mil and that was far less than the actual drop in starts. This suggests the November lull in starts could have been related to external factors or just a timing pause calculated to delay inventory coming to market until spring. Confused? Until earnings begin to slip I would still buy the homebuilders on any dip. Population density is growing, the equity markets are healthy and employees are seeing larger bonuses again. All this adds up to continued demand. The soft starts did not impact my favorite builder today. NVR announced they were going to buy back $400 million in stock to continue adding to shareholder value. The stock closed at $754 per share. That is slightly higher than the $405 per share from just six months ago. Sorry, no options yet.
Offsetting the bad news from Housing Starts the Jobless Claims fell -43,000 to 317,000. This was the biggest drop in three years and the lowest level since July-9th. The last two weeks were inordinately high at 350K and 360K respectively. Analysts suggested that these levels were due to an incorrect seasonal adjustment and now it looks like that could have been the case. I would also expect this abnormally low level could also be a factor of seasonal adjustments. Jobless numbers between Thanksgiving and year end should normally be ignored due to the scheduling of holidays and the clumsy attempt to adjust for them based on prior years.
The economic picture brightened again when the Philly Fed Survey came in at 29.6 and blew away estimates of 18.7. This was a huge jump and the highest level since July. This report completely erased fears from the disappointing Richmond Fed survey out last Tuesday. It is also in line with the NY Empire Survey out on Wednesday at 29.9 that also blew away estimates of 20.5. These are very strong numbers and they could be the leading indicators for a new economic surge.
The Current Account Deficit declined only slightly in Q3 from -$164.4 to $164.7. This insignificant drop is a function of several things but it was a real upside surprise given the ramp in oil over the quarter. Nobody thinks the downward spiral is over but this could be an indication of a slowing of that descent.
The bad news that rocked the markets was the announcement by FASB that stock options must be accounted in earnings statements by June-15th of 2005. This has been a hotly debated topic and one that could really change the earnings landscape next year. Merrill Lynch analyst Richard Farmer said expensing options would have taken more than 10% off S&P earnings over the last year. That is not the real problem. Tech stocks are where options are really used heavily and the impact to tech earnings is going to be huge. Merrill feels the impact to tech earnings could be as much as a -20% to -30% drop. This makes those already high PE stocks even higher and it put a really dark cloud over techs for early 2005. The opponents to this change vow to fight it in Congress and possibly the courts but that could be a long fight and it will not take away the cloud over Q2 earnings next year. This was one of the major factors for the sell off intraday today and one that will not go away.
The second reason for the drop was a sharp sell off in the Russell due to a monster reweighting scheduled for the close on Friday. The Russell indexes are adding 40 of the recent IPOs with three large ones going straight into the Russell-1000. This bumps three large stocks back down into the Russell-2000 in addition to the 37 remaining IPOs going into that index. Because some of these IPOs have been very large it means they will go into the R2K at a much larger weighting than hundreds of the other smaller stocks. In order for the mutual funds to adjust for the new index they have to sell a portion of each of the other Russell stocks they currently own to adjust everyone's overall ratio. With nearly $1 trillion indexed to the Russell indexes the amount of shuffling on any index change is huge. The Russell company itself advises holders of nearly $2 trillion in equities and directly manages $180 billion for clients. Just a little Russell trivia I thought you would be surprised to know. The Russell fell -1% today and retraced from its historic 648 high this morning to 640 on the afternoon dip. There was a buy program at 3:PM that produced a +3 point bounce or it would have been much worse.
The volume on the exchanges today was close to five billion shares and tomorrow it should be even higher. The Russell shuffle and the quadruple witching option expiration could push it over five billion. The added uncertainty of the option expensing could also add to selling pressure.
Symantec announced it was buying Veritas for $13.5B in stock but before the day was over the deal had fallen to only $10.6B based on the monster selling on Symantec. The stock has fallen from its $34 high last week to close at $25 today. This -26% drop in SYMC has created a major buying opportunity in my opinion. The combination of virus protection, data integrity, backup, recovery and storage seems to many like a match made in heaven. SYMC had experienced a monster run from $10.75 in just over a year. That number is even more amazing when you realize they split their stock 2:1 twice in the last 12 months. Split adjusted that is the equivalent of $43 to $136 in 15 months. Needless to say there was a lot of stored up profit and investors ran for the doors on the news rather than calmly wait to see what analysts said.
The LEAPs section is going to go LONG the SYMC 2007 $25 LEAP Calls OBL-AE currently $6.00, Buy JAN-2005 $22.50 PUT SYQ-MX currently $0.55 as insurance against a further drop. I view $25 as strong support and the drop very overdone. See the weekend LEAPS section for further details.
JNJ announced it was buying Guidant for $24.5B and traded higher on the news. Guidant was seen as adding another opportunity for JNJ and the company said it did not foresee any antitrust roadblocks to the deal. Noble Energy announced a $2.76B acquisition of Patina Oil and Gas and NBL dropped -$2.16 on the news and POG gained +4.69. POG was not a big operator with the majority of its fields in Colorado, Texas, Oklahoma and New Mexico. Oppenheimer agreed NBL needed to make some more acquisitions given the rapid depletion rate of the current Noble fields. Oppenheimer did think the deal was too expensive unless oil remained over $40.
It is amazing to me how many oil analysts can't see the forest for the trees when predicting oil prices. There are going to be a lot of shocked people in a couple years when oil is well north of $60. In my Profiting from the Coming Oil Crisis Report I detail the public smoke screen that is being used to keep civilians in the dark. You would think that analysts would have a little more on the ball and not be sucked into it so easily. Just last week the ExxonMobil CEO said energy demands were going to double over the next 20 years and we need to begin adding new sources of energy to keep up with demand. Some of the new sources he suggested were to burn garbage, wood and animal dung. Seriously! I don't know how far your SUV will get on that fuel or how many planes will be stopping at feed lots for a fill up.
The $45B in mergers today brought to $90 billion the total for December. That is the strongest period since 2000. Analysts have been predicting more activity because S&P companies have over $600B in cash on their balance sheets which is also a record. The IPO schedule is also running at a record pace with 21 IPOs this week alone. The huge sucking sound you hear is cash being pulled out of other stocks to fund the IPO frenzy. But, not to fear there was $3.2 billion in new cash deposited into fund accounts in the week ended on Wednesday. This was up from the $642 million trickle the week before. The end of year deposits have begun to flow and were it not for the FASB ruling on options I would be thinking SPX 1250 was just ahead. Now I am not so sure.
There are plenty of fund managers that are paid bonuses based on the years performance so they really need to keep those stocks pinned against the highs for at least two more weeks. Once the year-end passes into the record books, ledger books in this case, they can run for the hills if they are worried. I suspect a lot of them will be worried simply because of the uncertainty of what earnings will look like. Nothing has really changed at the companies only the way earnings are reported. Does that matter in the long run? I believe it does. Managers are judged by the companies they keep and the almighty PE ratios. If a company has an already high ratio, say 50 and earnings are $1 then the stock price is $50. If those earnings drop by -25% because of expensing options then earnings are 75 cents. A PE of 50 then equals a stock price of $37.50. OR, it could just mean a new PE of 67. I do not believe we will see either extreme but a blending of both. That means slightly higher PE ratios but slightly lower stock prices. This uncertainty cloud will start to weigh heavy on the markets after the first of the year when Q4 earnings are released. Many companies will begin to give guidance on what their earnings will be after options expensing and the street will have to decide how to deal with it. Just a heads up for everyone, the outlook has changed for 2005 but few have picked up on it yet.
Today the Dow notched a new eight-month high at 10726 and seems hell bent on a new multiyear high over 10753. For a change the Dow was one of the stronger indexes on the strength of the JNJ gains. That also boosted MRK +1.31 and PFE +0.66. There was a strong bid under the Dow that was not felt in techs.
The Nasdaq dipped back to 2140 intraday and closed just over 2146. The FASB news hit it hard as well as the Russell shuffle. After the bell CRUS and EFII warned and traders took $4 from Take-Two Interactive after they badly missed estimates. Later the semiconductor Book-to-Bill number was announced at 1.00, which was an improvement over last month at 0.96 but the news was not good. Orders fell -2.1% in November but billing feel even sharper at -6.1%. This forced an improvement in the BTB ratio but in reality the news was worse. This is not good news for Friday given all the other challenges from option expiration, Russell and FASB.
Based on today's events my outlook has changed. While we could continue to struggle higher in the face of the FASB ruling and the semi slump it would only be a jam job by funds trying to hold the market up for the next ten trading days. It is still entirely possible that the bulls will just ignore everything but I am much more cautious tonight. I would no longer buy the dips blindly as we have been doing over the last several weeks. We need to be much more selective in what we are buying and how long we are planning on keeping it. Those stocks with the highest PE ratios are usually the highest flyers and the ones with the most options exposure. This should shift the focus back to more of a value perspective and away from the hysterical PEs some techs now command. The rotation may not occur immediately and it could be a slow painful process. Once January earnings begin to appear I believe it will accelerate. Consider this a caution warning that an investor shift may be ahead. We need to see how the market digests this news and be more cautious until the outcome appears.
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