Almost A Breakout
The Dow and the S&P broke out to new multiyear highs but the Nasdaq continues to languish -120 points below its highs for the year. The mixed picture is improving but the strong divergence still exists. This was the fifth week of positive funds flows for the broader market but the 14th consecutive week of outflows from tech funds. Until the Nasdaq clears resistance at 2100 the current breakout will remain at risk.
Dow Chart - Daily
Nasdaq Chart - Daily
Friday started off with a bang when the payroll numbers for February came in with Goldilocks precision. The headline number showed a gain of +262,000 jobs and a big jump over the +138K average for the prior three months. This was just about the best number the market could have gotten with just the right amount of strength but not enough to send the Fed into a rate panic. This not too hot, not too cold number eased just over the estimates of +225K and the consensus whisper number at +250K. January was revised down -12K and December was revised up +22K, both well within the ranges. The job gains were broad based with manufacturing gaining +20,000 compared to a loss of -25,000 in January. Construction trades added +30,000 and personal business services added +81,000, more than three times the January gain.
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While the job gains were very market positive and suggest the economy is finally gaining traction the unemployment level actually rose to 5.4% as more people entered the workforce than were hired. The rise in unemployment along with a flat workweek at 33.7 hours for the fourth consecutive month gave the bond groupies reason to cheer. Bonds were bought, interest rates fell and the market celebrated. Average time out of work also slipped slightly to 9.4 weeks. All these things, while very small moves, suggest the economy is gaining traction and could have a big move ahead. The sleeping giant of the American economy appears to be awakening and analysts are already talking about a return to +4.5% or better GDP for Q1. Friday's jobs report was confirmation of positive economic conditions on many levels and with the earnings component remaining flat it suggests inflation is still under control. I know we have an average of 6-8 economic reports a week with half showing inflation growing and the other half contradicting but the consensus suggests it is still under control. Add in the falling Jobless Claims and rising employment advertising and the picture is definitely getting brighter. We have built a base over the last six months on average of +183,000 jobs and that gives us plenty of room to grow as the economy expands. Typically we could see growth to a monthly average of 250-300K but there are some challenges ahead. Mergers and acquisitions have reached the second highest level on record with 1195 deals announced in the last three months for over $200 billion. All of these mergers will result in job cuts as duplicate positions are merged and eliminated. This will continue to pressure the reported jobs despite the better economic conditions. How much this will drag on Jobs is unclear but it could deter the Fed from escalating their rate hikes.
The final Consumer Confidence number for February came in at 94.1 and right in the same range for the preliminary report. No big news here other than it was down slightly from January but that is old news today. The down markets and high gas prices were likely the major causes and a breakout by the markets tends to spike confidence/sentiment so the next report should be higher.
Factory Orders rose +0.2% for January compared to consensus estimates of a decline of -0.2%. Durable goods fell slightly but the increase in nondurable goods more than offset the decline. Backorders slowed slightly and inventory levels rose slightly but overall the report was positive.
When is a breakout not a breakout? The answer is of course when strong divergence is present. The Dow gained +107 and closed at three-year highs but the SOX closed negative -1.04 for the day and -10 for the week. MSFT, IBM, HPQ all closed down for the day despite the major gains in the indexes. Techs are just not participating and the minor gain in the Nasdaq only took it back to 2070, -120 from the highs for 2005 and only a gain of +5 points for the week.
This is a tale of two markets with the energy, commodities, housing and financial sectors leading the charge higher while techs languish in barely positive territory. Much of the problem this week was due to weakness in the SOX. Six major brokers raised semi stocks last week and succeeded in pushing the SOX to retest the strong resistance at 450. This week analysts on the opposite side of the picture chipped away at the semiconductor base and created fear and concern over the flurry of midquarter updates due out next week. We will hear from Intel, TXN, XLNX and ALTR and with multiple sector downgrades this week the fear is growing. Merrill Lynch said weak memory pricing and slowing demand could hamper the sector the rest of 2005. First Albany downgraded the sector on weakness in PC chip demand. JP Morgan said Intel could report lower revenue due to decreased demand for processors as evidenced by channel checks showing motherboard demand has been weak in 2005. With tech funds posting their 14th consecutive week of declines this type of chip worry ahead of the Q1 updates does not inspire buyers to part with cash.
The NDX has been stuck in a range from 1500-1540 since late January and is showing no indications of an impending breakout. In short there is simply no buying interest in techs and especially in big cap techs. This could eventually spoil the Dow rally and should Intel spoil the party next Thursday it could get ugly.
NDX Chart - 120 min
Crude Oil Chart - Daily
Oil prices may jump to $80 per barrel now and again, OPEC acting secretary general Adnan Shihab Eldin said on Thursday. He also said, "Prices are rooted in the balance between the world demand and supply, and plenty of other factors, including geo-political tension and possible pauses in oil supplies." That comment sent oil prices soaring to $55.20 and immediately halted the profit taking in energy stocks. The initial spike was immediately sold but the pullback was brief with Friday's close just under $54. The lack of a material retracement suggests there is more fear in the market than could be attributed to a random comment by an OPEC official. Peter Thiel of Clarium Capital Management said on Thursday that prices are headed to $100 over the next two years with a pause at $80. While I too have a $100 target for oil I doubt it will happen over the next two years, $80 yes but market forces should blunt the move much higher. The problem is simply rapidly declining production in 35 of the 48 oil producing countries and only minimal increases coming out of the rest. The only countries with sizeable production reserves are the ones which are politically unstable and that limits the amount of investment available. Nobody wants to invest billions in production drilling and infrastructure only to have the government nationalize it when you are done.
I received several emails asking if it is time to take profits in those stocks I profiled in my Oil Crisis report. My blunt answer is NO. The stocks profiled there were long-term holds and while we should see some volatility as demand and production ebbs and flows the long-term trend is up, way up. Consider the comments above about $80 oil from an OPEC official. I believe we are beginning to see the truth appear as each comment from somebody that should know appears to get worse. Consider also that unleaded gas futures reached an all time high at $1.54 this week. I expect that number to be $2.50 within two years if not sooner. We are just beginning to see the real signs of the oil crisis I wrote about and you better get used to those numbers.
I am seeing increasing comments about takeover activity in the oil patch. With Exxon saying they finished 2004 with less reserves than they had in 2003 the pressure is on to acquire oil assets. Since there have been no major oil discoveries in decades and the smaller discoveries today are coming at much greater cost the best way for the giants to grow is buy the dwarfs. Some targets are not really that small as in the case of Unocal. (UCL) Oil companies are floating on a sea of cash and I am sure they are hoping for at least one more pullback in prices so they can spend it. The other targets being mentioned are Encana (ECA), EOG Resources (EOG), Devon Energy (DVN), Burlington Resources (BR), Anadarko Petroleum (APC) and Sunoco (SUN). If you look at the charts with an eye on buying their stock the sight will scare you. However, most oil companies are trading at PE ratios that are barely double digits. Chevron Texaco for instance is only 11, BP 11, XOM 11 and this is after their +22% gains for the year. Chevron actually pulled back slightly after it was rumored they might start a bidding war for Unocal but they are still a buy. An acquisition of UCL would be positive due to a strong overlap in their asset base. However, they would have to go to war with China (bidding war) to win. China has been eying the Indonesian assets of UCL in an effort to acquire oil close to home.
Lehman joined the party on Friday and said oil prices would probably be over $40 for the rest of the year. Way to go out on a limb there Lehman but I think that train has already left the station. I listened to one analyst on Friday who made a very strong case for rising oil prices from an economic perspective not a shortage perspective. His claim was the economic boom currently underway in China and India was beginning to spark a sharp pickup in growth in many other countries as well. His case for global growth pushing demand much higher was presented well and made very good sense. The challenge as we already know is that growth needs oil to lubricate the economic wheels and that commodity is in short supply. It also explains why the high oil prices are not depressing the markets more than just on a temporary basis. If global growth is beginning a strong expansion then higher oil prices can be absorbed to some extent. The moral to the comments above is buy oil stocks on any dip no matter how small and hold them until 2010.
Oil is not the only commodity exploding in price. Copper set a new high this week over 1.50 and this sent Phelps Dodge to a new high as well with a +3.93 gain on Friday. Metals and chemicals are breaking out to new highs with stocks like Nucor (NUE) and Dow Chemical (DOW) benefiting. The commodity index broke out to a new high over 300 on Monday with a gap open and it closed at another all time high on Friday at 309. This broad based commodity move seems to confirm the idea that the global expansion is accelerating and conditions for the rest of 2005 should be good for business.
A key point we should all realize is that hedge funds as well as mutual funds are putting every spare dollar into commodities as the current hot spot for 2005. Until this sector cools there is not going to be a lot of money sloshing around in techs or stocks in general. There is a roaring bull market in commodities and the equity markets are just tagging along for the ride hoping to benefit from the loose change falling through the cracks.
Commodity Index - Weekly
Semiconductor Chart - 90 min
Earnings estimates for the rest of 2005 are rising almost daily. Three months ago the earnings growth estimate for Q3/Q4 were barely over +5%. Today Q3 earnings growth is estimated to be +13.3% and Q4 +10%. This is nearly double the estimates from the end of 2004. Analysts were caught off guard for each of the last two quarters and missed reality by quite a bit. They are now seeing an increase in profitability that is sustainable. Maybe we should start worrying with that big a revision.
All this good news sent the Dow, S&P, Transports, S&P Small Caps and S&P Midcaps to news highs to close the week. The Russell-2000, SOX and Nasdaq are lagging although the Russell did break strong resistance at 640 on Friday. Volume was moderate at 4.25B shares and advancers were 2:1 over decliners, 3:1 on just the NYSE. Still it was not as bullish as the indexes suggest. The majority of the gains on the Dow were due to CAT +2.20 (+20 Dow points), MMM +1.56/+10, DD +1.45/+10 with UTX, JNJ, BA and HON the supporting cast. Not really a consensus when the rest of the Dow gained less than 50 cents and GM, HPQ, IBM and MSFT were down. I see MSFT finally settled at breakeven but on a +100 point day a breakeven performance is as good as down.
The talking heads on TV were gushing about how bullish the market was on Friday but I don't see it. It was a good day but not spectacular. The Dow only ended up +90 for the week and it gained +107 on Friday. You do the math. Part of the problem is weak fund flows. TrimTabs said +$2.8B flowed into funds for the week ended on Wednesday. Unfortunately $2.6B of that went into overseas funds not funds that invest in U.S. stocks. That leaves a paltry $200 million to divide up amongst approximately 7000 U.S. stocks. It is amazing we were up at all.
Next Thursday is not only the Intel midquarter update but it is also the five-year anniversary of Nasdaq 5000. If Intel turns in a disappointment it would almost be appropriate. There are no material economic reports next week so all eyes will be on Intel, TXN, XLNX and Altera and of course oil prices. I am really conflicted on my bias given the lackluster techs and declining SOX while the Dow/S&P were breaking out. I went back and looked at the very short term charts and it appeared the majority of the lift came on the backs of about six buy programs. We had some strong short covering at the open on the jobs report, another buy program/short covering spurt at 10:00 on Factory Orders and then flat from 10:30-1:30 with only a very slight upward bias. The ending spurt came on a buy program at 1:50 and short covering held us at the highs until profit taking hit at the close. In summary I believe the jobs number caught some big players off guard and the Factory Orders stopped the post-open drop. This caused more short covering that pushed the Dow over 10900 and there was just enough buying pressure to hold it there until the rest of the bears threw in the towel at 2:PM. The more I looked at the intraday chart the more I doubt it has legs. Do I want to bet against it? Definitely not.
On Tuesday I suggested some consolidation at the highs ahead of the Intel numbers would be good and allow a breakout after their report. That is exactly what happened until Friday's open. We consolidated in a range of 10775-10860 with some pretty heavy volatility as is typical at questionable tops. I suggested we wanted to be cautiously long over 10850 given the Nasdaq lagging below 2100. With the breakout looking more like short covering than real buying we could drift back down to that range ahead of Intel on Thursday. I would still want to be cautiously long just in case real buying breaks out but the key word there is cautiously. We have an OPEC meeting in mid March and the Fed meets in two weeks to raise rates again. We are also approaching the beginning of the earnings warning cycle in mid March. Lots of obstacles for the bulls to climb while dragging the Nasdaq.
As long as commodities remain the focus of investors the equity markets could continue to wander. When/if commodities roll over the drop could be sudden and steep. I am sure some funds will shift cash back to equities before the end of March to present a diversified picture in their quarterly reports and this could give stocks a boost. This should be an interesting week.