A Revolting Development
After two weeks of trading at the resistance highs the markets sold the Intel news and have retreated back to the bottom of our current range. The positive Intel news failed to excite tech buyers and the Nasdaq remains the weakest index. The market failure to make the break higher and now the acceleration to the downside has turned into a revolting development for equity bulls.
Dow Chart - Daily
Nasdaq Chart - Daily
The markets opened higher on Friday as tech buyers bought the Intel news but it was short lived. Sellers appeared almost immediately and they never left. Helping to sour sentiment was the second largest trade deficit on record in January at -$58.3 billion. This was a +$3 billion increase from the December level at $55.7 and closing in on Novembers record high at +$59.4B. One reason given for the increase was a jump in apparel imports when the quotas expired. Oil prices were a positive impact as they fell in January but the bounce over the last month is sure to send February's deficit to a new high. The trade balance with China widened by more than $1B with Canada also growing by +$1B. The Canadian growth came mostly from imports of petroleum products.
The growing trade deficit, falling dollar and some comments from Greenspan on Thursday night all combined to weigh on bonds and sending interest rates higher. The yield on the 10-year rose to 45.35% and a seven-month high. With a Fed meeting in our near future the rise in rates could be telegraphing fears that the Fed will soon remove the measured pace comments and add a 50 point hike to punctuate the current rate hike series. While Greenspan has been taking both sides of the deficit picture in recent speeches he still cautions that there is no free lunch and the deficit will have to be brought back into reality eventually. His comments suggest the Fed will continue to push rates higher and possibly much higher. Greenspan continues to warn that anyone betting on low rates ahead will lose money. This was not good news for the markets and helped sour sentiment in spite of Intel.
Energy prices rebounded with oil gaining +89 cents to close at $54.43 and put an end to thoughts that a real bout of profit taking was in progress. Oil appears to be building a support base at $53 and is staying very close to its recent highs. The International Energy Agency revised its demand estimates upward by +290,000 barrels per day to +1.81 mbpd growth for 2005. They said robust growth in the United States and China was increasing demand at a rapid pace. Duh! Despite the increase in demand OPEC is not expected to raise production at its March 16th meeting on Wednesday. Venezuelan Energy Minister Rafael Ramirez said on Friday that OPEC had no reason to expand production and should maintain existing quotas. Other OPEC members, Iran, Qatar and Algeria have also voiced opinions that quotas should not be raised.
China's oil imports rebounded in January from a 14-month low suggesting the economic dip had passed. Weaning OPEC members from +$50 oil is going to be harder than healing a crack addict from cocaine addiction. I am still hoping to see a decent pullback at the end of March but so far there are no signs it will be soon. Lee Raymond, XOM CEO, said on Wednesday that the current price levels were not justified by fundamentals and oil fell from over $55 to $53 but the dip was very brief. I believe Raymond downplayed the story so as not to be the bearer of bad news. If XOM says oil supplies are shrinking then they could be seen as the bad guys for not exploring/discovering more. It is easier for them to stay on the sidelines and out of the battle and just keep cashing the profit checks. Why step in front of the firing squad if you don't have to? I have readers in the oil industry email me almost daily with reports that my oil scenario may have been too cautious and they see conditions accelerating to a conclusion much sooner. Time will tell but the key point is we already know how the story ends.
CRB Index Chart - Daily
SOX Chart - Daily
Intel did not make any friends with their mid-quarter update. They raised revenue guidance to the high end of their range but traders said it was simply a case of raising very conservative guidance to only mildly conservative. They raised their guidance to revenue of +$9.2B-$9.4B from prior estimates of $8.8B-$9.4B. The stock fell -65 cents on Friday after Andy Bryant said they expected a "seasonal quarter toward the better end of our forecasts." Far from exciting guidance from the largest chipmaker. They did raise their gross margin expectations to 57% from 55% but it was mostly on lower than expected startup costs for a new production line. This produced a strong sell the news event as traders hoping for signs of exploding tech demand were disappointed. Friedman Billings Ramsey lowered their outlook for the chip sector and removed AMAT from its focus list saying PC demand was simply not growing. The SOX closed at a two week low at 428 and appears to be headed for a retest of support at 420. The SOX has tried to break resistance at 445-450 for nearly a month with the first test of that level back on February 15th. The SOX was about the only support for the Nasdaq over the last three weeks and should it continue its drop the Nasdaq could easily retest its lows by weeks end.
There was just no excitement in the market. We are in that period of the quarter where there is really no reason to buy other than hopes for a new bull market to appear. So far that hope has been dashed several times in 2005. The resistance highs continue to hold despite the Dow and S&P actually touching new highs before rolling over. On the bright side the selling was slow and on light volume. The A/D line was only slightly in favor of decliners but A/D volume was 2:1 to the downside. One point of interest was a sudden spike in the new 52-week lows to 142 and the high for the year. In fact new lows have been over 120 for three straight days with new highs falling into the 150 range after being as high as 650 back in early March. The 124 new highs posted on Thursday was the lowest level since January 6th. So, while the volume was light the internals have taken a sudden turn for the worst.
Mutual funds saw inflows for the sixth consecutive week with $2.96 billion hitting fund accounts last week. 88% of that went into overseas funds leaving only a trickle for U.S. stocks. According to TrimTabs since Jan-1st more than three times the amount of cash inflows have gone overseas that that staying in U.S. funds. Last week emerging market funds saw their largest inflows since 1994. Tech funds saw their 16th consecutive week of outflows so it is no surprise that the Nasdaq finished at its lows. CSFB published a study this week showing that retail traders were mostly absent from the market with hedge funds accounting for 50% of the volume on the NYSE and the London Stock Exchange. They also said 70% of ETF volume was directly attributed to hedge funds. The bottom line to this paragraph is that individual investors are unsure about the future of the market and are waiting on the sidelines for better visibility ahead. With the hedge funds controlling the majority of trades the volatility could continue to increase. It is still a bull market in commodities and that has mixed implications for equities. The biggest of which is a serious cash drain as funds play the commodity momentum and avoid stocks.
Next week is a minefield of economics with 23 reports mostly clustered in the Wednesday-Friday period. We also have a reweighting of the S&P to a new structure. The S&P is going from a market cap weighting of "shares outstanding" to a "shares available to trade" method. This should produce a negative bias to the market for the week. For instance, 40% of Wal-Mart shares are held by insiders and are not available for trading. By changing the weighting to value only the 60% currently in circulation it reduces the weight of WMT on the S&P by a considerable amount and index fund managers will be forced to sell it. Multiply this by the entire S&P and it could be a significant impact. Standard and Poors will change one-half of the S&P this month and the second half in September. Still, since the odds are good that most large companies will drop in weighting there should be selling on the larger companies and light buying on the smaller companies to bring everything back into parity. I believe this should provide a negative bias that could be accentuated by option expiration.
The Dow lost -166 last week and closed right at the bottom of its two week range. If the negative bias on the S&P is correct then the same S&P selling should hit the Dow since all 30 Dow stocks are major components in the S&P. This suggests we could see a return to 10650 and the support from late February. The SPX closed right on 1200 and its two-week low. It also has risk to 1190 or lower. The Nasdaq appears hell bent to retest the 2025 level we saw in late January and it appears conventional wisdom was right after all. I mentioned on Tuesday that the rejection at 2100 could be the beginning of another market cycle and conventional wisdom suggested we short the Nasdaq again for the current cycle. Unfortunately I lacked the faith to make it a firm recommendation with the Dow and S&P at three-year highs. Fear not there is always another entry just ahead.
I believe we are going to retest the lows but I don't yet believe they will be broken. Until the pattern changes I would be a dip buyer at Nasdaq 2020, SPX 1085. We have what should be a strong earnings cycle just ahead and there have not been any indications that earnings will disappoint. I still believe oil will ease as we move into spring and that should give the equity markets a positive bias. The wild card here is the S&P reweighting and whatever impact it has on the indexes. As long as those levels mentioned above do not break we are still in an uptrend with just a bit of normal consolidation. Should the Nasdaq break 2020 then 2000 becomes a critical psychological support level and a break there could see 1900 very quickly. As I said I don't see that happening yet and I am still looking for a trading bounce from 2020. Buy the dip to 2020/1185 if oil is under $53 and look to exit stocks if oil moves over $56. If you don't have a strong reason to trade this week it might be a good idea to watch and wait. This could be a pivotal week and we should know by Tuesday night how the bias is going to impact option expiration. I will revisit this conversation on Tuesday and hopefully from those support levels mentioned above.