Hanging By A Thread
After a week of mixed results and several rebound attempts the markets traded right on the edge of the cliff until 20 min before the close. A large buy program that boosted the A/D line +800 issues appeared just before the close to pull the major indexes back from the brink. The buy program was futures based with the S&P futures spiking +7 points over several minutes. The spike was just enough to close the Nasdaq and S&P with miniscule gain for the week and prevent the S&P from stretching its string of weekly declines to four weeks. Market manipulation anyone?
Friday's economic reports did not help the bullish sentiment with the GDP headline number falling to growth of only 3.1% for Q4. The consensus estimate was +3.5% and the whisper numbers were as high as +4.5%. Several analysts have speculated that the Microsoft dividend alone would have added +1% to the number. It that was the case then the real GDP number would have been closer to +2%. The factors contributing to the growth were a +4.6% rise in consumer spending and a monster +14.9% jump in capital spending. The capital spending was undoubtedly due to the one time tax credit for equipment purchased before 12/31/04. With the one time factors of Microsoft and the tax credit unable to push the GDP into a respectable range then what is the current quarter going to bring? The biggest drag on the GDP was the record trade deficit in Q4. This subtracted -1.73% from the headline number. This is the silver lining to the GDP cloud. It means our real internal GDP was something in the +4.8% range if you ignore the deficit. Economists will tell you that it can't be ignored but investors really only care that our economy is growing and the ex-deficit number suggests the growth was not as slow as the headline number indicated. Inflation did appear to rise substantially with the personal consumption expenditure (PCE) rising +2.5% in Q4 compared to only +1.3% in Q3. The core PCE also rose at +1.7% compared to +1% in Q3. With the Fed meeting next week traders will be cautious as all indications suggest the Fed is getting nervous.
The Employment Cost Index rose slower than expected with the weakest year over year growth in wage costs on record. With the employment market still soft there is competition for positions and employers do not have to pay up to get quality people. However, benefit costs continue to soar with 60% of the growth in wage costs for the quarter going to benefits. Employment costs rose +0.7% for Q4 and were relatively tame. It would be tough to get a roaring inflation fire going without wages to feed it. This is a partial offset for the Fed to the GDP mentioned above.
Proctor Gamble (PG) announced they were buying Gillette for $57 billion and made Warren Buffet even richer. Berkshire Hathaway is a major shareholder in Gillette and the spike in the stock price provided a whopping +$800 million one day gain for Warren. He said it was a dream deal and would create a company that would have over $60 billion in sales and over $200 billion in market cap. This set off a flurry of merger speculation as to who was next. One suggested combination would be Colgate (CL) and Kimberly Clark. (KMB) Both companies are nearly the same size with KMB only slightly larger. A combination of these two companies would allow the merged company to compete better with the PG/G combination.
Thursday the Dow was shredded by the Cat and today was a bone crusher hit by Merck. A federal court invalidated a patent by MRK on Fosamax, its blockbuster osteoporosis drug. Fosamax had $3.2B in sales in 2004 and with the new ruling MRK will lose the patent in 2008 instead of 2018. This knocked MRK for a -3.16 loss and another Dow drop. Teva Pharmaceuticals stands to gain the most with its generic Fosamax once the patent expires. Combine the drop in Dow components MRK, PG and Boeing and you have a loss of over -40 Dow points from just those three stocks. The Dow closed down -40.20 for the day.
The Iraq election dominated trader chatter in the afternoon and the references on stock TV seemed to increase in intensity as the day progressed. It appeared nobody wanted to take a position before the weekend with countless unknowns ahead. Over a dozen separate car bombs were detonated in Iraq and five U.S. soldiers were killed on Friday. With the election still a day away the violence is only going to get worse. We don't know if there will be dozens killed over the weekend or hundreds or even thousands. The terrorists are determined to prevent as many people from voting as possible and officials are expecting the worst.
OPEC meets on Sunday but the outcome is already known. The OPEC president again said there would be no cut in production. This produced another drop in oil prices to $47.18 after spending most of the week near $50. A weather forecast for the northeast suggested there would be a warming trend and this also relieved demand concerns. The OPEC president again said they would look at the demand again in March to determine if they should cut production to maintain the price. Last year they cut production too much in the spring and then spent the rest of the year trying to catch up to demand shortages. In separate news the Russian oil company Yukos said it would not export any oil in February because it lacked enough cash to pay the export duties. There are no estimates for the drop in total exports because other Russian companies are expected to pick up the slack.
If you are an active trader and live on the west coast then get ready to set your alarm an hour earlier each day. The NYSE is considering opening at 8:00 or 8:30 ET each day and very few traders are happy about it. The traders on the floor are negative about the change saying it will not increase their profits and only increase their costs. The NYSE is hoping to capitalize on the current premarket trading from news events, earnings, etc. The electronic markets open for trading at 8:AM and the NYSE wants part of this volume. On days were there are significant developments many millions of shares are traded on the electronic exchanges. The current betting line on the time change is an 8:30 open and it will start on May-1st.
It was announced after the bell on Friday that Lockheed Martin won the $1.7B contract to build the next generation of presidential helicopters. LMT beat out Sikorsky on the deal and breaks with tradition by using a foreign-designed aircraft. The aircraft will be assembled in Texas but about a third of the work will be done in Europe. The first helicopter will be ready by 2009 and will eventually be a fleet of 23. Just how many helicopters can one person use at a time?
The markets swooned on Friday despite a flurry of decent earnings on Thursday night. The bulls can't get any traction and money is still flowing out of funds. AMG Data confirmed on Friday what TrimTabs has been saying for two weeks that January will end with negative flows for the month. With the average inflows over $20 billion since 1990 and recent years over $40 billion the complete absence of any flows is a major market negative. Several recent reports suggest that large investors are moving to defensive positions ahead of looming uncertainty. With $900 billion in hedge funds the rising bearish sentiment is shifting much of that money to the sell side as well.
The Dow is only off -4% for the year despite the strong decline. It seems stronger because of the extreme bullishness as we entered 2005. A -4% drop is just a blip in the long run but there is increasing worry that this could turn into a real correction instead of just minor profit taking. For the Dow to experience a normal -10% correction it would need to trade down to 9800. Friday's close at 10427 was right on the neckline of that head and shoulders I mentioned on Thursday. Were it not for the last 15 min buy program that added +35 points it would have closed under 10400. It literally was hanging on by the slimmest of threads to that 10400 level and the market manipulation at the close was the only saving grace.
The challenge now is determining if the weakness was due to the impending Iraqi elections or just another bout of the defensive selling we have seen since January began. Fortunately we will have that election answer very soon but that is not the last word. The Fed meets on Tuesday for a two-day session and there is come real confusion over what direction they will take. There was considerable speculation about three weeks ago that the Fed would make one more cut and then pause. However, over the last two weeks the comments have been running more towards removing the measured pace language in anticipation of larger rate hikes to head off inflation. This uncertainty has the bond groupies in a tizzy and traders unsure of where to place bets. This, along with the Iraq elections could be the major reason for the lack of buyers. Those who want to be long the market are slowly ticking off the January events and earnings guidance and waiting for the all clear signal before jumping into the game. That all clear may not be until after the Jobs numbers next Friday.
Dow Chart - 180 min
With the Dow clinging to the 10425 neckline by the slimmest of margins we could be looking at another leg down if the Iraq news is worse than expected. Most expect dozens if not hundreds of attacks over the weekend. We might actually find that much worse projections were already priced into the market and a low death toll actually positive for Monday. Should the Dow lose its grip on 10400 there is light support at 10370 and the 100-day average. The 200-day average is slightly lower at 10279, which corresponds with the 50% retracement of the October rally. If the bears are fixated on forcing a full -10% correction neither of those support levels will matter for long. If the market weakness was due to the election cloud then Monday's open should see a move back to retest 10500 resistance while we wait on the Fed.
The Nasdaq is holding on slightly better than the Dow to the weeks gains. After +10 point buy program at the close the Nasdaq ended just above the middle of its range for the week at 2035. Since the Nasdaq is compromised of more than 30 stocks it is less reactive to a major drop in a single stock than the Dow. Resistance remains 2055 and support at 2020. The Nasdaq was helped by a firming SOX this week. The flood of positive chip earnings had pushed the SOX back over 405 by Friday morning despite the somewhat cautious earnings guidance for the sector. The morning sell program at 10:40 knocked it back to 397 but it clung to that level and refused to go lower despite some decent volume in chips. The closing buy program pushed it back to 400 and nearly +20 points over last Monday's lows. I was impressed by the SOX strength over the last three days and I believe it is suggesting tech sellers are running out of ammo.
SOX Chart - Daily
SOX Chart - 15 min
The Russell is lost and can't find its way home. For three weeks the Russell has shown some very uncharacteristic intraday volatility. Conflicting fund money flows are whipping it around like a butterfly in a windstorm. The range of movement has been from 605-625 and we closed right in the middle at 613. January is normally a small cap month but the tide has turned. Funds are being forced to sell the small caps to raise money for withdrawals. Any excess cash is being invested in highly liquid large caps where it can be extracted on a moments notice. That strategy is also failing with numerous large cap favorites seeing sudden news related drops. There appears to be no safe port in this storm.
I think cash is still a position while the SPX remains in neutral territory between 1160-1175. For five days we have been unable to hold over 1175 resistance and the rebound attempts were lifeless at best on the S&P. There appears to be an effort to hold the S&P over 1167 but baring an Iraqi relief rally on Monday that effort may fail. The January downtrend is still intact and critical support at 1160 could be the next causality.
While we wait on Iraq, the Fed and Friday's Jobs Report I am still recommending only small long positions over 1175 and remaining flat between 1160-1175 with a strong short under 1160. This takes the worry out of picking a market direction and eliminates getting chopped to pieces with the numerous range bound head fakes.
Enter Very Passively, Exit Very Aggressively!