The markets can't decide which personality they want to assume as we move deeper into 2005. Dips are bought and rallies are sold and no personality trend is able to dominate the other. Volatility is the only constant with the direction alternating on a daily basis. The month end tape painting from last week was sold strongly on Monday but that dip was bought once again and the Dow and S&P edged back to near their highs for the year. Will the real market please stand up?
Dow Chart - Daily
Nasdaq Chart - Daily
The morning started off with the ISM posting its seventh consecutive monthly decline at 55.3 and well off the 63.5 high for this economic cycle posted in January 2004. The rate of decline appears to be slowly accelerating to the downside but any number over 50 still indicates an expanding manufacturing sector. The ISM was not greeted warmly and the drop cooled the opening bounce in the markets. New orders and production slipped only slightly while inventories fell sharply to 48.6 from 52.8. The drop in inventories under 50 suggests there may be a pickup in manufacturing ahead in order to replenish depleted inventories. We did see inventories dip under 50 several times over the past year with immediate rebounds each time. Prices paid fell to 65.5 in February and well off their high of 88.0 last April. This indicates a weakness in the supply chain that is allowing companies to obtain a better price for components. This weakness could be due to the slowing demand and a buildup of components in the supply channels. The weak ISM could be slightly positive for the market because it suggests the Fed may slow its measured pace of rate hikes given a continued slowing in the manufacturing sector.
Construction Spending rose +0.7% in January but fell -0.5% from the December rate. The headline gain was just slightly better than consensus at +0.6%. The biggest gains came in the Utility sector at +7.9% growth and Highways and Streets at +4.4%. Office buildings fell -0.5% and Manufacturing fell -3.5%. Personally I would not be excited by a spending number that was almost completely dependent on highways and utilities. Since those components don't indicate growth in the broader economy I don't think it would be market friendly. This lukewarm spending report also helped squash the morning rebound.
February auto sales fell to an adjusted rate of 15.7 million units, down from a 16.2M rate in January and the 18.4M rate in December. The February rate was the lowest rate since June. The drop was blamed on the end of year incentives pushing buyers into December and on several strong winter storms keeping buyers off the lots.
GM sales fell -12% in February and a sharper drop than Ford's decline at -2.9%. This was the ninth consecutive monthly decline for Ford. Chrysler rose +7.3%, Toyota +11% and Nissan +10.1%. GM said it was cutting production for the quarter by -45,000 units due to a buildup of inventory to more than an 80 day supply. GM likes to keep inventory levels under 65 days. Toyota sales are strong with its Prius 55mpg hybrid selling as fast as they can make them. At the oil crisis seminar I attended yesterday it was announced that over 20 new models of hybrids were going to hit the market over the next three years with all the major manufacturers getting into gear.
The biggest news of the day was an upgrade of the chip sector by JP Morgan. JPM raised Intel to overweight from neutral and the sector to bullish from neutral. They said the sector appeared to be bottoming on such things as gross margins, plant utilization and earnings growth. They felt the sector should begin to improve by the end of the second quarter and expand into full recovery in 2006. This powered the SOX to close within a couple points of major resistance at 450. Not everyone was so positive on Intel or the sector in general. The Gartner group lowered its growth estimates for chips in 2005 to +3.4% from its prior +5.2% estimate. Sanford Bernstein said their estimates for growth were even lower than that with a flat year over year growth target. Despite their flat growth expectations Bernstein was still positive on Intel based on new products and gross margin expansion into 2006. First Albany reiterated a sell on Intel and the sector based on expected Q2 weakness and channel checks on chip products. Motherboard shipments are very soft and slowing and this suggests processor sales at Intel will also be soft into the summer. There is nothing like strong differences of opinion to fuel a volatile market.
After the bell Novellus released earnings that disappointed on guidance. NVLS raised revenue expectations slightly but said bookings would be flat. They also moved earnings guidance to the high end of their prior range but the stock was punished in after hours trading and lost -1.33 on the news. This was not a bad report but it echoed the sentiment of many analysts that a recovery has not yet begun and may not begin until the second half of 2005.
SOX Chart - Daily
XLE Oil SPDR Chart - Daily
At the energy seminar I attended on Monday the consensus was for a natural gas crisis sooner than previously expected. Previously the peak in gas production had been anticipated for 2010 or farther but that has accelerated to something in the 2008 range. The rush to produce gas fired electric plants over the last ten years has put a strain on current supplies and it is requiring a strong drilling surge just to maintain the current levels. According to Matthew Simmons, a respected investment banker in the energy sector, gas pressures in the northeast during the recent cold snap dropped to dangerously low levels. Had it lasted another day or been just a little colder there would have been shortages in the system.
Since 1994 over 34,000 gas wells have been drilled in the U.S. with no real increase in production capability. The U.S. derives 23% of its energy requirements from natural gas and that number is growing although gas supplies are not keeping pace. 15% of our natural gas comes from Canada and that equates to 50% of their production. Canada drilled 6,400 gas wells in 2004 in an effort to maintain that export flow. The problem is the life of a gas well life is much shorter than that of an oil well. Average gas output from new wells drops -50% within two years and -75% within four years. With U.S. demand accelerating almost daily the need to bring even more wells online more quickly is also accelerating. Unfortunately, like oil, the easy gas has already been found and wells are now going much deeper and are much more expensive than prior finds. The big pockets have already been tapped and more exploratory wells are coming up dry. I won't bore you with more of the facts I outlined in my Oil Crisis report but the last fact from yesterday's meeting should drive the point home. Utility bills are expected to double by 2008 and triple by 2010. How much was your utility bill this month? How will $5 gasoline impact your driving?
GE, the second biggest U.S. company, said in a letter to shareholders that GE was in the best shape ever. Immelt said GE had weathered a tough period and their energy, healthcare and transportation divisions were poised to grow faster than the rest. He repeated his claim that GE would produce double-digit growth and thanked GE shareholders for sticking with the company. GE closed right at $35 and right on support for the last four months. Immelt may be excited about the company's future prospects but investors have been less than thrilled with GE's stock performance.
The markets performance over the last several days has been directly related to the performance of the SOX. The Dow has rebounded to press its resistance highs for the year at 10850 and closed very close to that level. The SOX has also rebounded to its resistance levels at 448 and just under breakout resistance at 450. A breakout here could generate some serious short covering by the bears and price chasing by those bulls that were hoping for a seasonal Q2 dip. This is a critical level for the SOX and for techs as a result. With the Novellus numbers tonight as well as Intel CEO Craig Barrett saying inventory numbers are generally approaching low levels there could be a breakout soon. If the SOX breaks out the Nasdaq weakness we have been watching for the last several weeks could evaporate.
Currently the Nasdaq is trading right in the middle of its recent range from 2020-2100 but it is starting to see some improvement in the internals. We should not turn bullish on the Nasdaq until we break that 2100 resistance but a SOX breakout over 450 would be one more stepping stone to that 2100 level. The dip in energy stocks could help the Nasdaq as funds rotate from the energy sector ahead of any spring demand slump and into techs ahead of the April earnings cycle. Unfortunately the Nasdaq has a major roadblock on March 10th with the Intel mid-quarter update. The Craig Barrett interview today gave no clue to their outlook other than discussing new products and low inventory levels. The SOX bounce could be in anticipation of a positive Intel report but we are likely to see some profit taking before next Thursday's (10th) update. The SOX has already rebounded +17% from the January-24th lows and a breakout could add another +5% and that sets up some real profit taking potential before Intel's update.
The Dow close so near to the 10850 level along with the SOX at 448 indicates to me there is a potential breakout move ahead. However, given the volatile nature of our recent market I question its strength. The S&P has failed just under 1215 every time and while we could be setting up for another failure my bias is changing toward a breakout instead. There has not been a material change in sentiment but there is a rising bid under the market. Dips are being bought much quicker and on slightly stronger volume. Internals are improving and oil near $52 is not weighing on the market. I still see Nasdaq 2100 as a key level but a breakout by the Dow and S&P could quickly weaken that resistance. It is going to be a tough call as the week progresses and it is not without its dangers.
Greenspan gives testimony again on Wednesday before the House Budget Committee and we never know how that will end. Lawmakers were highly criticized after the last testimony for not asking more questions specifically directed at the economy. They will probably take this opportunity to rectify that shortage. There is a flurry of employment reports this week that will be anchored by the Nonfarm Payrolls on Friday. Payrolls have been lukewarm around +135,000 for the last three months and it is time for something to change. With the decline in Jobless Claims we should see an improvement and the consensus has risen to +218,000 and some whisper numbers over 250K. The problem here is expectations. With expectations rising the potential for disappointment is also growing. With the Challenger Layoff Report, Monster Employment Index and Jobless Claims between now and Friday there will be adjustments to those expectations on a daily basis. How that will impact the market is anybody's guess. If we do get a Dow/SPX breakout I would want to be cautiously long despite the lagging Nasdaq. The setup is not the way I would have liked to see it with the Nasdaq over 2100 but market conditions appear to be changing. Be ready to roll with the punches once in breakout mode as anything is possible. I would love to see caution return and have us build a base at this higher level until after Intel but sometimes we have to trade what the market gives us and ignore the divergences.
Market Wrap Archives