Inflation was the catch-word in Wednesday's trading. Market watchers scrutinized economic releases for signs of inflation and poured over Fed speeches and the Beige Book for clues as to how the FOMC felt about the issue. Inflation had another meaning, too, with hopes for this earnings season perhaps inflated by the scarcity of warnings. Competing bullish and bearish chart characteristics already predicted choppy trading conditions for Wednesday, and the attention garnered by each release contributed to the impression that trading conditions might be choppy.
By the end of the day, that choppiness had resolved into a strong downward push that thrust many indices below their 50-sma's again. The SOX, long ago falling below its 50-sma, dropped below 400 by the close. Internals had been bearish all day, with the advdec line negative. Most sectors dropped, with the SOX; GHA, the GSTI Hardware Index; DDX, the Disk Drive Index; NWX, the Networking Index; and XAL, the Airline Index among the sectors dropping more than two percent.
Annotated Daily Chart of the SPX:
The presence of two confirmed long-in-the-making inverse head- and-shoulder formations may make it difficult for the SPX to reach any downside target predicted by this H&S on the daily chart, if it's confirmed. Competing chart characteristics often point to confusion among bulls and bears and sometimes lead to choppy trading conditions. The SPX may not yet be finished building that right shoulder, for example, and might chop around at the appropriate right shoulder level another day or two before either confirming the formation or negating it.
Other indices show some of the same chart characteristics.
Annotated Daily Chart of the Dow:
The Nasdaq's chart proves more difficult to decipher.
Annotated Daily Chart of the Nasdaq:
Wednesday opened to a busy earnings and economic release schedule, with some release times and dates shaken up from the usual. At 7:00, the MBA Refinancing Index jumped 19.1 percent from the previous week's. Refinancing activity fell as a total percentage of mortgage activity, however. The Composite Index also jumped, by 16.2 percent on a seasonally adjusted basis.
In an industry-related release at 8:30, the Commerce Department released housing starts figures for December, characterizing the 10.9 percent seasonally adjusted increase as occurring at the fastest monthly rate in seven years. Starts numbered a seasonally adjusted annual rate of 2 million units, up slightly from the forecast 1.9 million. All regions and subcategories saw a rise in housing starts. Less than two hours later, a component of December's CPI was to show that housing prices also rose 0.2 percent. In all of 2004, housing prices rose 3 percent.
A look forward wasn't as cheery, with December's building permits falling 0.3 percent on a seasonally adjusted basis. While housing starts measures the number of units upon which construction has begun, building permits offers a preview of the future, as permits often lead housing starts. Some discounted the decline in permits, however, saying that the number can be volatile and that it takes several months to see a trend. The number can be affected by weather conditions.
Later, the Beige Book release was also to show that residential mortgage lending was generally slower. However, the DJUSHB, the Dow Jones U.S. Home Construction Index, proved to be one sector- related index that eked out a gain, climbing 0.31 percent.
With inflation the catch-word, the dollar was also in focus pre-market. Overnight, The Bank of Japan's Governor Fukui made a statement that impacted the dollar/yen pair during the pre-market session. He avowed that during next month's G-7 meeting, Japan would oppose any wording of the joint statement suggesting that Europe has unfairly absorbed dollar weakness and that Asian countries should absorb more.
Why should U.S. equity investors care what the dollar is doing? A commentator on CNBC summed up traders' impressions this morning. He said that if there is a feeling that the dollar has bottomed, U.S. markets should see record inflows from Asia and Europe.
That statement was made after the 8:30 release of the CPI data, with that data also figuring into the dollar's behavior. Falling crude prices in December helped keep consumer prices low, with prices decreasing 0.1 percent. Excluding energy and food prices, the core CPI climbed 0.2 percent, with both numbers characterized as being in line with expectations.
It's when examining the yearly numbers in the context of Fed goals and recently rising crude prices that some worry arises. The Federal Reserve's goal of maintaining core inflation rates between 1.5 and 2.5 percent was met, with the core CPI rising 2.2 percent, but that increase was still the largest since 2001. The headline number rose 3.3 percent for 2004, the largest increase since 2000, perhaps dampening hopes that the Fed might be through raising rates for a while. While core CPI was in-line with expectations, both for the month and the year, continued higher crude prices could sharpen the beaks of the hawks on the FOMC.
Wages don't seem to be adding pressure. Adjusted for inflation, real hourly wages declined 0.8 percent in 2004, falling for the first time in ten years. Not adjusted, hourly wages rose 2.7 percent. Weekly wages declined 0.2 percent. The Labor Department also noted that initial jobless claims fell 48,000 for the reporting week, but some note that weather and other factors might have impacted that number.
After the blizzard of economic releases at 8:30, equity futures climbed, but the dollar fell. Ten-year yields rose. Fed Governor Bernanke was speaking before the market open and hurried to qualm inflation fears, saying that risks hadn't risen over the last six months. That dollar decline was to be temporary, as was the climb in equities. After climbing for another hour, ten-year yields came off their high, too, drifting lower into the release of the Beige Book, steadying ahead of the release, and then falling further.
Interest in equities had been damaged by pre-market results by JP Morgan Chase (JPM), Lucent (LU) and Pfizer (PFE), as well as Motorola's (MOT) after-hours report Tuesday. By the close, JPM had dropped 1.45 percent; LU, 7.56 percent; PFE, 1.66 percent and MOT, 7.05 percent.
Two of those four, JPM and PFE, are Dow components. JPM's earnings disappointed, while LU's revenues did. MOT received three downgrades after yesterday's earnings report, and led communications equipment stocks lower. In the afternoon, the Beige Book release was to show that the Dallas district, at least, experienced slowing demand for consumer communications equipment.
Headlines proclaimed PFE's quarter soft, with both strong drug sales and cost-cutting measures contributing to profit gains but with its adjusted EPS failing to meet estimates. The company reported a 7 percent revenue increase, but that revenue was in part attributed to a 24 percent increase in Celebrex sales and a 57 percent increase in Bextra sales. An FDA advisory committee meeting as to the safety of those two drugs will be held in mid-February, with their further contributions to PFE's sales in question.
Perhaps due at least in part to uncertainty regarding the outcome of that upcoming FDA meeting, PFE declined to offer guidance for 2005 until an analyst meeting planned for April. The outcome of that meeting isn't the only uncertainty regarding PFE. Of interest to PFE and many other multinationals is a law signed late last year that allows for a much lower rate for repatriation for domestic use of earnings from foreign subsidiaries. Discussions at PFE and offices of other multinationals concern how much money can be repatriated, under what conditions, and for what uses.
As expected, markets chopped around into the 2:00 release of the Beige Book Report, with that report's summary including a statement that during December and early January, inflationary pressures remained in check. While costs had risen for manufacturers and builders, the consumer saw only modest cost increases for final goods and services. The Boston and Minneapolis districts reported a sharp rise in input prices, with modest to high price increases in the costs of building materials in Atlanta, Kansas City and Minneapolis. Other districts reported mixed results. The Dallas district reported that stiff competition stopped firms from passing rising costs through to the consumer.
Nine out of twelve districts saw factory output rise. Consumer spending increased, with the Fed reporting that the much-disputed holiday sales season saw retail sales above year-ago levels in many districts. Economic activity continued to expand. In the context of a generally strong real estate market, some districts noted slowing in both residential real estate and construction activity. As had been shown by the previous Labor Department release, some firming was seen in labor markets, but no increase in wage pressures. Districts reported a mixture of results related to auto sales, with some districts seeing a rise in inventories "above desired levels."
Whatever market watchers had hoped to see in the Beige Book, they didn't find it. Although crude prices closed down $0.35 and some earnings had proven strong, none of that was enough to overcome the earnings disappointments listed above or those from LUV, AMD and NWAC or even event fear ahead of the inauguration. After the bond market closed, equities plunged.
After the close, EBAY and QCOM joined other reporting companies, and inflated expectations from traders sent them sharply lower when they didn't meet those inflated expectations. As Jim Brown noted in the OptionInvestor Market Monitor, EBAY blew through multiple support levels in after-hours trading after disappointing on profit guidance, but dropped all the way into possible support. After-hours trades plunged all the way toward the 200-ema and -sma. EBAY had beat on Q4 profit and revenue, and announced a 2-for-1 stock split. The conference call pinned that lowered guidance at least on part to increased investments in China, a strong point rather than a weak one to some watchers.
QCOM was also dropping in after-hours trading. QCOM reported Q1 sales of $1.39 billion against expectations for $1.40 billion, with profit of 28 cents excluding items against expectations of 27 cents. However, the company guided analysts to expect Q2 revenue of $1.35-1.45 billion, lower than the previously expected $1.49 billion. It also predicted earnings lower than expectations, but many cautioned that accounting changes could be responsible for those misses.
Other reporting companies included COF, missing expectations; FFIV, beating expectations; QLGC, falling as this report was prepared after reporting Q3 profit a cent lower and revenue slightly lower than expected; PLNR, missing on earnings and warning for 2005; SYMC, falling after reporting higher-than- expected sales and forecasting revenue higher than current expectations; and SWKS, falling after reporting profit of 9 cents against expectations of 13 cents, coming up shy on sales, and forecasting next-quarter revenue below current expectations. Whatever market watchers expected to see, they found their expectations inflated.
The release of crude oil, gasoline, and distillate inventories was pushed back to 5:00 p.m. The Department of Energy and American Petroleum Institute numbers differed as widely as they often do, with the API reporting crude inventories up 6.0 million barrels while the DOE reported them up 3.4 million barrels; the API reporting distillates down 450,000 barrels and the DOE, up 880,000; and the API reporting gasoline up 5.4 million barrels and the DOE, up 1.7 million barrels. Estimates had been for a rise of 1.5 million barrels in crude inventories, so both the API and DOE reported a much-bigger-than-expected buildup. Estimates had been for a 1.00 million barrel increase in gasoline inventories, and those beat by estimations of both the API and DOE, too.
However, it's the supply of distillates that's been of most concern during the winter months, and it was in that number that the API and DOE differed most. The API reported a drop of 450,000 barrels and the DOE a gain of 880,000, with the DOE's number close to the expected rise of 750,000.
With crude traders appearing to accept the DOE's more reassuring number, crude dropped after-hours. A drop below $45.68, the 50- sma, or a climb above $50.00 may be important, but for now crude prices remain at a level where the validity of the potential H&S remains questionable. It hasn't yet been invalidated, but may be on a climb much above $50.00.
Annotated Daily Chart for Crude for February Delivery:
Thursday's economic releases begin with December's Leading Indicators at 10:00, concurrent with the Fed's Poole discussion on the economic outlook at a speech in Mississippi. Those events are followed by the January Philadelphia Fed at noon and the Fed's Yellen following up Poole's Mississippi address on the economic outlook by one on the same topic in San Francisco. Money supply figures are to be released at 4:30, but the Semi Book-to-Bill number at 6:00 might draw the most attention.
Much-watched earnings tomorrow include before-the-open releases by a number of retailers and airlines and after-the-close releases by KLAC and XLNX.
As noted on many of these charts, long plays currently look iffy. Many indices appear to be in right-shoulder building exercises, with potential confirmation of head-and-shoulder formations looking imminent, but "looking" imminent and seeing follow- through are two different matters. If already in bearish plays from rollovers beneath the right-shoulder levels, follow indices down with your stops, noting potential profit-protecting levels mentioned on the various charts, with the necklines being obvious levels that might prompt a bounce.
If there's a bounce tomorrow from those neckline levels, options traders, paying spreads and facing decay in the likely case of falling volatility indices while equity indices bounce, may not be able to capitalize on a choppy upward move within a potential right shoulder formation. Tomorrow, ahead of the inauguration and the Semi Book-to-Bill number, for that matter, may not be the right day to make a bet on a long position from the neckline area of potential H&S formations, betting against the chart formation being confirmed. Shorts could be surprised by such a bounce and the markets could run away to the upside, but the wiser choice may be passing up any such potential play if it occurs tomorrow.
Bearish players should exercise caution, too, as symmetry suggests that there may be another day or two of choppy shoulder- forming behavior before indices decide whether to confirm those formations and head downward or invalidate them and climb toward recent highs. Decide before the day begins whether you will be willing to hold overnight tomorrow if markets plunge and you've accrued bearish profits.
Bears will have real difficulty if the indices chop back up
toward the tops of those right shoulders tomorrow into the close.
From this distance, that looks like a good bearish entry, but
that's ignoring the change in tenor that might be present Friday
morning and the role that event risk might be playing in the
markets' declines. Would that be a good bearish entry ahead of
potential event risk? Probably not with anything but lottery
money. It might be better to wait until volatility settles out
Friday morning to make a decision, realizing that a gap move
might be possible, thwarting plans for new entries.