Stealth Rally Nearing A Breakout
In a series of hops, skips and stumbles the markets continue to move higher but you have to look hard to see it on the Nasdaq. The Dow and S&P have quietly moved to new highs for the year but the Nasdaq remains stuck under 2100 although it continues to sneak in small daily gains. Sudden sprints higher have been met with sell programs producing a choppy and fitful market but one that is slowly moving higher.
Dow Chart - Daily
The market received mixed messages again from the flurry of economic reports today. The Chain Store Sales for last week were flat at only +0.1% and that was for the pre Valentines week. Late minute shopping by procrastinators will be tallied in next week's numbers. Year over year growth is slowing at +1.7% and down significantly from the +4.0% or greater numbers we saw in Dec/Jan. Since Jan-15th this number has been declining and suggests the consumer is running short of cash until tax refund season arrives.
The retail sales for the month of January actually fell -0.3% compared to a +1.1% gain in December. The biggest component problem came from autos which fell -3.3% for the month. Without autos consumer sales actually rose +0.6%. Other areas showing weakness were Furniture -0.1%, Electronics and Appliances -0.6%, Building Materials -0.3%. Strong sectors were led by Clothing and Accessories +1.8% and Gasoline Stations +1.8%. That last component should give us a clue why retail sales in general are slipping. Oil is holding near $48 and gasoline prices are holding at higher levels.
The NY Empire State Manufacturing Survey continued the recent trend of declines but to a lesser amount than the Kansas Fed yesterday. The NY survey fell to 19.2 from 20.1 the prior month. This compares to a drop in the Kansas survey to 37 from 50. The Philly Fed Survey is due out on Thursday. Consensus estimates for today's NY survey was for a slight gain to 21.0. The biggest drop came in back orders, which fell from +5.7 to -12.2. Prices received also fell sharply to 13.2 from 27.7. New Orders, Employment and the average workweek also fell. Shipments and Inventories were the only categories to rise. This indicates the bounce in production has now surpassed the Q4 surge in orders and manufacturers are now seeing an unwanted build in inventory with orders slowing.
To further emphasize this fact the December Business Inventories rose only +0.2% according to the numbers released today. The inventory to sales ratio fell to a record low of 1.30. This shows the Q4 buying cycle was particularly strong and more than likely spurred by the special accelerated year-end tax credit. With that buying incentive now history there is likely to be a decline in orders for Q1. This is being seen in the recent manufacturing surveys as discussed above. Neither of these situations is specifically negative for the economy or the markets but bear watching in anticipation of a Q2 rebound.
The NAHB Housing Index fell two points to 68 for the second consecutive decline. Builders appear to be losing some confidence as we move towards the spring selling season. This is the first time back under 70 since last fall's post-season dip. With this drop coming just ahead of the spring selling season it suggests some real softening in the sector rather than just a seasonal dip. We all know the building boom will eventually bust or suffer a substantial slow down. Many recent reports suggest that housing prices are between +25% to +50% over valued in certain areas including California, Las Vegas and many communities in the North East. A reversion to the norm in those areas should not be seen as eminent or a bursting of the bubble. I strongly doubt a reversion will occur but a cooling of buyer interest could continue as long as the negative news articles are repeated in the press.
While there were a number of economic reports today none of them really had any impact on the market. The most material impact came from another "fat finger" trade early in the day. The Pacific Coast Exchange reported 900,000 QQQQ option contracts traded in error shortly after 10:AM. This produced a massive +20 point jump in the Nasdaq that temporarily broke the 2100 level. The sellers appeared shortly afterwards and the Nasdaq retraced the entire 20-point spike before 1:30. The exchange said they were busting the trades due to their "obvious error" rule. This bounce provided the only excitement on the Nasdaq for the day. There was a slight upward tick to the index after the retracement and several analysts suggested it was trades being unwound from the morning error. Had you owned QQQQ options before the spike and exited during the error you were probably patting yourself on the back all afternoon. Those that recognized the spike to Nasdaq 2100 as a prime short entry point obviously jumped on the gift when presented. When the PCE announced late in the day all those trades were going to be busted there was a scramble to unwind the subsequent positions. If your long sale was busted and you already spent the proceeds buying/shorting something else then odds are good some traders would need that cash back fast or end up with a margin call at tomorrows open. Same with anyone who shorted the top at 2100 and found their trades busted. This is never a fun event and it is amazing the Nasdaq posted any gain for the day considering the afternoon uncertainty.
There was also some chatter about the fat finger trade being part of option squaring for the quadruple witching coming this Friday. So far the Nasdaq had seen very little volatility since the two buy programs on Friday morning. It appeared traders were content to let their positions expire with the Nasdaq holding the line at 2080. Today's trading may have rocked everyone's boat but with a +6 end for the day it appears calm waters have returned.
Market analysts seem to have forgotten the majority of their fears now that the January dip has been retraced. Many are upgrading their forecasts for market performance in 2005 and trying to get the retail investor back on the train. ISI took a big step today by raising their earnings estimates for Q1 from +9% to +13.4% after the big Q4 analyst earnings miss. Consensus estimates for Q4 had been for earnings growth of +15%. With over 80% of the S&P-500 already reporting the actual number is close to +21.4% growth. The analyst consensus for Q1 was +7% and slightly below ISI. Apparently the economic forecast for 2005 is being upgraded due to a slowing of inflation concerns and the continued measured pace by the Fed. The Goldilocks economy is coming back after three years of absence and analysts are beginning to get almost giddy about the future, at least the very near future. Current estimates for the next four quarters still show a significant drop later in the year as comparisons become harder. Current earnings growth estimates for the S&P are Q2 +7.5%, Q3 +3.7%, Q4 +0.6% and Q1-2006 +5.6%. Earnings after Q1-2006 flat line at about 5.5% per quarter but that far away they are so unreliable they are just a guess.
The average consensus miss on earnings growth is around 3%. There is a round of head scratching underway to try and decide why they missed it so badly for Q4 at 6%. The answer being given is underreporting of guidance by companies to avoid missing the target. Companies fear legal battles under the new accounting standards and it is easier to under report than face angry shareholders. I believe it was due to two factors, the election and the one time year-end tax credit. I believe consumers and corporations held off making purchases until after the winner was announced. When the election was concluded without any material problems and Bush remained in power the consumers breathed a sigh of relief and opened their wallets. Companies fearing a reversal of the republican tax incentives had waited to see who won before making those high dollar purchases. These two factors produced a strong year-end profit bounce.
This can also be seen in the cash flows from foreigners. Stock purchasers by foreigners jumped +400% in post election November compared to October. Purchase of treasuries by foreigners jumped +57% in November. Cash inflows from overseas continued in December but not quite at those same rates. Clearly there was a lot of breath holding going on not only in this country but overseas as the election wound down. A clear victor and a lack of any terrorist event removed any roadblocks to investment and spending.
The next obstacle was the Iraq elections and investors paused in January as fears of problems surrounding the event paralyzed everyone into inaction. Once the event passed the inflows into mutual funds and the markets resumed. Oil prices were expected to begin falling and although we did see a dip to $45 it was very short lived. Fears of future supply are growing and the current battle for future production between India and China are increasing those fears. Saudi Arabia said yesterday that it was going to increase its rig count to 70 from 34 in an effort to increase capacity. Previously Saudi had been willing to just replace declining production but the emphasis has shifted. They are now going to make a concentrated effort to increase production. T. Boone Pickens was interviewed today and he reiterated his $60 before $40 prediction and said we should see $60 before the end of 2005. According to many analysts Saudi is currently pumping at full capacity and Pickens echoed this belief. As I have stated before it is a known fact that once fields begin to decline the rate of decline accelerates at the same rate initial production increased in a bell curve format. Saudi has been rapidly increasing the amount of water pumped from existing wells and this indicates a coming end to production. In the case of Saudi, water is pumped in on the far edges of fields in an effort to push the oil towards the pumps. This tactic is beginning to reach the point of diminishing returns as the amount of water showing up in the oil output increases. If the water is moving completely through the field with a decrease in the amount of oil produced it shows the fields to be nearly dry. Pickens believes the sudden doubling of the rig count is a race to keep production at current levels as existing fields accelerate into decline. Now add in the continued growing demand for global oil and you see why prices are not declining into the normal demand slump in March. They may still decline slightly but Pickens is adamant we will see $60 before $40.
After the bell today AMAT reported earnings of 17 cents that beat the street's estimate of 16 cents. The actual whisper number was even lower at 15 cents. There was a lot of negativity surrounding the event despite the move higher in the stock price from the January bottom. Revenue also beat estimates and AMAT guided revenue flat to slightly higher for Q1. They also raised earnings guidance to 16-17 cents and analysts were only expecting 15 cents. Gross margins also rose slightly to 44.4%. It was a very good report given the current state of the semiconductor sector. Futures rose slightly on the news. TSM told investors on Monday that sales rose +8.8% in January after 13 months of declines. Thursday we will get the semiconductor book-to-bill for January and a higher number would be well received. We have seen fewer orders than shipments for the last four months and a general weakening for quite sometime.
Not faring so well after the bell was NTAP, which announced earnings inline with street estimates but guided lower. The stock was hammered for nearly a -$4 loss in after hours trading. The company argued that it was standing behind prior estimates of +35% growth for 2005 but traders were not buying it. This could be one of those cases I stated earlier of cautious quarterly guidance to avoid a costly miss.
The Dow, S&P and SOX are all moving nicely higher but the Nasdaq remains the weakest link. The Dow closed at 10837 and a new closing high for the year. It has broken numerous resistance levels since the Jan-25th low and is very close to breaking out to a new high for the year at 10868. The Dow leadership is rotating almost daily and this rally appears to have legs although we need to make that break to confirm it.
The S&P finally broke over the 1205 level and is also nearing the 1215 resistance that should provide the final test. Once over 1215 the bears should be silenced and a spring breakout begin. Unfortunately the Nasdaq is still the anchor these indexes must drag as they move higher. The 2100-2110 level is proving to be solid resistance and well below an equivalent breakout at 2185. The Nasdaq is suffering from a big cap revolt. The major stocks in the Nasdaq led by MSFT, DELL, CSCO and ORCL are trading flat to dead. Yes, dead. There is no life to be seen in any major tech issue other than Intel. Until this situation changes there is little the Nasdaq can do but cling to 2100 and hope the other indexes lend a helping hand. The SOX is trying and after tonight's AMAT news we could see another attempt on Nasdaq 2100 tomorrow. The SOX closed right below 440 and is extending its gains from the January lows. A move to 450 would produce a very nice cup and handle formation on the SOX and a potential breakout from the last eight months of weakness.
For Wednesday we will be forced to undergo a prolonged appearance by Alan Greenspan as he gives his semi-annual report to Congress. There is some fear, based on recent comments that he will try to shock the bond market out of its doldrums. Greenspan would like for rates to rise slightly to increase pressure on the economy and relieve the need for the Fed to bear the burden on its own. He is likely to warn again of higher rates ahead in an effort to rock the boat slightly. While that will be the focus of the bond groupies the majority of stock traders will be looking for signs the economy is continuing to improve and that the Fed is nearing the end of its rate hike cycle. This means the G-man will have to walk a narrow line to try and push rates higher without pushing stocks over the cliff. Assuming we don't suffer a serious Greenspeak event the markets appear prepared to move higher. Remember we get the instant replay with revisions on Friday and he will be able to correct any misstatements from tomorrow should his words not be taken as intended.
For the rest of the week I am still watching Nasdaq 2100 as the key. The other indexes can move higher without the Nasdaq but only in ragged fashion. Should the AMAT news tonight start a fire under the Nasdaq then we could see a decent rally commence once Greenspan concludes, assuming of course no literary disaster.
Continue to enter passively and exit aggressively until the Nasdaq is over 2100.