Night and Day
The difference between Thursday and Friday was as clear as night from day. Thursday's mediocre session was caused by losses in Internets and chips. Friday's blazing rebound was led by chips as they broke out over resistance and finally confirmed the index scenario I laid out this week. Internets were down again but were ignored as money poured into the market and into techs and shorts were forced to cover.
Friday morning started off with a bang after the Jobs report came in weaker than expected but still showing modest growth. Bad news turned into good news for the bulls as the report confirmed continued growth but not at a pace fast enough to incur speed brakes by the Fed. This was a case of the porridge being not too hot and not too cold but just right for investors. The headline number showed +146,000 new jobs were created in January and that stretches to seventeen the string of months with positive jobs growth. The last three months have averaged +137,000 jobs and the pace appears to be picking up slightly. The current recovery period has been the longest since the great depression and January's employment finally exceeded the prior cycle high from February 2001. The bond market celebrated the news that the Fed may continue to remain in a measured pace mode and yields fell to two month lows.
The inflation monster is far from dead with the ECRI Future Inflation Gauge jumping +1.1% for January. Over the last four months the index is up nearly +3% at 120.0 and spiking to levels not seen since Sept-2003. Were it not for the drop in commodity prices led by oil in December it would have been much higher. The annualized growth is currently +4.5% on a trailing 12-month basis but we jumped +3% in just the last four months. If this rate of growth continues we could easily be in the high single digits by the end of 2005. This index contradicts the current thought process that inflation is under control and will remain tame. The bond market and investors ignored this report again. It is not normally a market mover because it moves in such small increments. A couple more months of these strong gains and it will get a lot of attention.
The Michigan Consumer Sentiment Survey final for January came in at 95.5 and nearly unchanged from the first reading of 95.8. This was actually a positive surprise after the four weeks of market weakness. The future conditions component did fall from 90.9 to 85.7 but the present conditions spiked from 106.7 to 110.0. This seems contrary to me, as I would have expected the present conditions to deteriorate given the market and the uncertainty about the Iraq elections. The lack of a drop in sentiment and the neutral jobs report appeared to be the right recipe for investor comfort. Sentiment remains at its recent highs, the economy appears to be growing and jobs are being created. Add in a strong rebound in the markets this week and investors/consumers should be seeing clear skies ahead.
We have weathered a strong event risk calendar over the last four months without any material negative events. Almost everything went as planned and the future calendar is relatively clear of any potential problems. Finally we can get back to investing without an eye on potential terrorist events or political uncertainties. The administration is saying things like tax cuts, spending cuts, fixing social security and growing the economy. It is the same motherhood and apple pie promises normally made by administrations but it actually appears we could see some movement this time around. Consumer sentiment should continue to improve and with interest rates still at low levels we could see another round of buying in homes and cars. Oil prices should also continue to decline as we move into spring and seasonal demand weakens. With the market rebound the future suddenly appears rosy.
Even Greenspan made positive comments about the deficit on Friday. I don't think anything has changed since his tirade on the deficit a couple months ago but suddenly his view is also moderating. Greenspan said the decline of the dollar should be reaching a point where imports could slow and the deficits begin to shrink. He said the lower dollar had improved the competitiveness of U.S. exports and is basically leveling the playing field. The market celebrated his comments as a softening of stance that could continue on into future Fed policy. Keeping rates low helps keep the dollar low and improves our trade balance. Of course we should not forget that the administration favors a strong dollar. Talk about saying one thing and hoping for another. Greenspan also pushed the use/abuse of the English language to a new high. He referred to budget cuts as "reducing federal government dissaving" instead of reducing federal spending.
When the tide turns it is not always obvious in the first few minutes but once the inflow begins it floats all boats. The same is true in cash flows into the market. For the first time this year we had strong inflows into equity funds. According to AMG Data there was a sudden injection of liquidity this week with $4.3 billion flowing into stock funds. TrimTabs said the last six days saw +$4.7 billion. This was the strongest week since early December and you saw what happened to the markets. According to TrimTabs over $50 billion went into money markets and savings accounts in the month of January. This compares to only $10B in January 2004 when $40B went into stocks. There was clearly a unanimous move by retail investors to wait for the Iraqi election and the inauguration events to pass before risking those retirement funds in the markets. Once the Iraqi all clear was given last Sunday the cash began flowing and according to those fund trackers the pace is suddenly accelerating.
Is it just me or has the Goldilocks economy finally returned? We are seeing nice sustainable growth, low rates, lack of material event risk, a rising market and for the immediate future reasonable inflation. Profits are coming in much higher than expected at +23% growth for Q4 compared to First Call estimates of only +16%. Over 75% of the S&P companies have reported and 68% of those companies have beaten estimates. Buybacks are exploding with numerous companies announcing a billion dollar per month program. TrimTabs said nearly $20B in buybacks would occur in Q1. That is a huge number and should continue to provide s floor under the market. Mergers and acquisitions are also accelerating and that also puts cash back into the market.
The only real negative on the horizon is the threat of conflict in other Mid East countries. Condoleeza Rice said in Germany that an invasion of Iran was not on the agenda "at this time". Syria may be another matter. There has been an increasing fear that the U.S. could take action against Iran to halt their nuclear weapons program. The thought would be if we don't do it Israel will and that would be very negative for the region. It is widely reported that the U.S. has covert agents in Iran scouting targets and trying to determine if the Iran program is real or imaginary. Bush took shots at all the terrorist countries in the State of the Union speech and his verbal warnings appear to be strengthening. Several knowledgeable sources have said Syria is the next target based on satellite reconnaissance over the last two years showing training camps, stockpiles and ex-filtration routes into Iraq and other countries. The current consensus is that Bush will use Syria as an example of his continued attack on terrorism and punishment of terrorist supporting nations. He is expected to ramp up the verbal warnings even further in hopes of getting other countries to lean on Syria. Expecting no cooperation he will mount a massive surgical strike on these camps as a further warning that we are ready to carry the fight anywhere. It would be another warning that the U.S. is in the region and we plan on being the bully on the block until everyone cleans up their act. The good news is that most Americans are oblivious to this developing scenario and until the saber rattling begins to take on a harsher tone the markets should ignore it. Most sources put any move up to a year away. Other than this the global event horizon is clear for 2005.
Energy prices should continue to fall into spring as the demand for heating oil slows. This will reduce gas prices and the general public will assume the high energy prices of 2004 are history. That is far from the truth and a new development this week continues to highlight the moves underway on the global energy chessboard. Venezuela President Chavez is rumored to be in talks to sell Venezuelan oil to China instead of the U.S. Venezuela is the 10th largest producer and 5th largest oil exporter in the world and 60% of its oil is sold in the U.S. Chavez is a strong critic of the U.S. and wants to reduce its dependency on us. They ship 1.5mbpd to the U.S. and the majority is sold through Citgo, a major retailer on the east coast. Citgo owns 14,000 service stations in the U.S. and eight refineries. Citgo is part of the Venezuelan state oil company PDVSA. Citgo supplies PDVSA with nearly $25 billion in revenue per year. Chavez signed several oil deals with China last weekend and is rumored to be working on a much bigger agreement. There is growing risk to Conoco Phillips and BP assets in Venezuela and both are restricting further investment. This will further reduce expected future production from that area.
Should Venezuela terminate oil sales to the U.S. it would not change the global supply/demand equation as other nations would simply shift their sales to compensate for the new direction. Unfortunately it would force the U.S. to rely even more heavily on Saudi Arabia and the other mid east suppliers and the very unstable political climate currently brewing. This could be part of a larger game plan by those nations to shift our dependency to supplies that could be cut off in an instant. Another reason I don't expect the U.S. to leave Iraq for several years. Venezuela is an OPEC nation and one that is not under Arab control. If OPEC has suggested behind closed doors to Chavez that this would be a way to get back at the U.S. and further their gains they could be working on this as a joint effort. I fully believe that OPEC wants the U.S. to be fully dependent on them so they can continue to raise the prices and threaten us in retaliation for our involvement in Iraq. Our attempt to destabilize the political climate in that area and instill democracy is a direct attack on the ruling families who helped fund the 9/11 attack and numerous other terrorist events.
It was also revealed this week that China helped finance the phony Yukos asset sale in Russia. Remember also that China is trying to lockup production in Canada. Are you starting to see the global picture forming? Lock up supplies well in advance of the coming peak in global production and you control your own fate for the decades to come. China has seen the future and is acting on it while the rest of the world is still napping. The bottom line here is buy oil stocks on the dips. The long-term oil outlook is growing more bearish on supply and bullish on prices.
The stock markets not only retraced a strong percentage of their January losses but in several cases actually broke the overhead resistance. The tsunami of cash pushed the indexes to the point where shorts were forced to cover at resistance breaks and those waiting for confirmation of the move were forced to chase prices higher. It was a great day and a great week for the bulls.
I am not going into great depth on the index analysis today because Leigh Stevens does that very well in his weekend Index Trader Wrap. However, I believe it is critical to note that the index scenario I have laid out all week was given a huge boost by the Prudential chip upgrades. The SOX was the index holding the rest of the markets back on Wed/Thr and Friday's explosion of +17 points, +4.35% was a major relief valve. Prudential changed its rating from unfavorable to favorable on the sector saying the fundamentals should bottom in the first half of 2005 and begin to grow again by Q3. Ironically the upgrade was not sector wide with XLNX, ALTR and LLTC drawing downgrades BUT increased price targets. The SOX roared past the 410 resistance to close at 418 and well over the January resistance. The next material resistance is 430-435 and a move to 440 would produce a bullish cup and handle formation.
The breakout in the SOX released the Russell and it tacked on another +8 points to 637 and it is also above all the January resistance. Small caps came back into favor with the resumption of retirement cash flows and fund managers breathed a sigh of relief. The SPX paused briefly at the strong 1195 resistance and for a few minutes it appeared it might hold. The soaring SOX released its weight on the S&P and when the break over 1195 came it triggered some strong short covering. The S&P closed just under 1203 and well above its January resistance.
The Nasdaq was supposed to be the next index to breakout but news in the tobacco sector sent Altria much higher with a +3.26 gain. An appeals court said the tobacco industry did not have to pay $280 billion in penalties wanted by the Justice Dept. All the major tobacco companies posted huge gains late in the day when the ruling was announced. This provided a very strong late day surge to the Dow and by association all the stocks in the Dow. According to TrimTabs much of the cash flowing into the market is going into ETFs. When an investor buys an ETF the manager of that ETF has to buy all the stocks represented. A strong surge by a company like MO sends other Dow stocks higher and causes short covering in the ETFs thereby pushing all 30 Dow stocks even higher. Quite a lot of complex hedging and investment strategies now revolve around the ETFs and that increases the amount of program trading. Sudden moves in single stocks in an ETF produces broader reactions as those ETF programs are triggered.
As a result the Dow surged ahead of the Nasdaq in the index race and resistance levels tumbled like dominoes. 10600, 10650 and even 10700 fell to the short covering and price chasing. The Dow closed up +288 for the week and +344 off its January 25th low. When corrections are overdone the markets tend to react strongly once buying returns. Who would have thought last week we would be talking about 10850 as the next resistance level to conquer?
Unfortunately the Nasdaq is now the weakest link and while the +29 point gain on Friday erased the -17 point drop on Thursday it still finished below the 2100-2110 resistance level we have watched for the last month. I would like to think the race is on because we know from experience cash follows cash. Once a move is confirmed it can run on momentum for several days. The Nasdaq could gap open on Monday and blow right past 2120 but I would not count on it. The Nasdaq has a very nice uptrend from the Jan-25th bottom but it lacks the excitement in the other indexes. The networkers and Internets refuse to join the party and until that selling ends the other indexes may be forced to drag the Nasdaq anchor behind them. Once over 2110 it could turn into a drag race when short covering hits the Nasdaq over that level.
I have to admit I don't see very many negatives going forward and that worries me. When everything appears the most positive is when disaster normally strikes. The VIX hit a new multiyear low on Friday of 10.90. (VXO 10.75) Internals were very strong with new highs at 632 and the highest level since Dec-2nd. Up volume was nearly 4:1 over down volume with advancers better than 2:1 over decliners, 3.5:1 on the NYSE, 4:1 on the S&P. Were it not for the weak Internet and networking sectors on the Nasdaq I believe it would have been much higher. With the SPX over 1195 everyone should be aggressively long and we are back to buying the dips until the trend changes. It is entirely possible this uptrend could last until March earnings but I would sure hate to bet the farm on it. We need to continue to trade the trend the market gives us and right now that trend is up. I do expect some profit taking from this weeks gains but I believe the dips will be bought by those that missed the train. Have a great week!