The Dow's rebound from 10400 on Wednesday turned out to be a cruel April Fools joke on the bulls. Friday's economic news showed a growing worry about the economy and funds immediately stripped away the end of quarter window dressing they had applied only two days prior. Oil soared to new highs and equities closed at their lows. It was not a pretty picture.
Chart - Daily
Nasdaq Chart - Daily
Friday morning started off bad economically but great for the bulls with the Jobs report showing a gain of only +110,000 jobs compared to the +255,000 expected. This was the lowest gain since July-2004. Even worse the gains for February were revised down to +243K from +262K and January was revised down to +124K from +132K. With the lower than expected numbers from March this multi-month revision brought the monthly average for the first quarter down to only +159,000. The economy must produce an average of +150,000 jobs per month just to breakeven with the number of new workers moving into the workplace. The +159,000 average barely covered that new worker inflow and suggests the economy is much weaker than previously expected. The weaker than expected jobs numbers were far below what anyone expected and sent shockwaves through the bond markets.
The decline in hiring appears to be pressured by rising interest rates and higher commodity and energy prices. Companies faced with rising costs on almost every front have to find ways to chip away at those costs. They can't control interest rates, energy or prices for raw materials but they can control employment costs by cutting back on hiring. The drop in jobs growth suggests wages will also be pressured at a time when energy prices are taking a bigger bite out of consumer budgets. In theory this pressure on the consumer should slow the rate of inflation due to lack of fuel in the form of excess cash to feed it.
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The markets celebrated the drop in jobs as evidence the economy was still weak and confirmation the Fed could pause its measured pace of rate hikes. The Dow spiked to 10568 on the news despite a sharp jump in oil prices. The spike was short lived as the ISM announcement reversed the jobs reaction. The ISM fell to 55.2 from 55.3 but more importantly extended its period of monthly declines to 14 months. The cycle high was 63.6 in January-2004 and it has been trending down ever since. Friday's 55.2 headline number was the lowest level since September-2003 at 53.7. The +10 point spike into January-2004 has nearly been erased and we are closing in on the critical advance/decline level at 50. Any number over 50 indicates economic expansion and any number under 50 indicates economic decline. Friday's 55.2 is barely above stagnation and the continuation of the 14 month decline indicates the economy is not well. The equity markets focused on the sharp jump in the prices paid index to 73.0 from 65.5 as evidence of a rapid buildup in inflationary pressures. This number was cussed and discussed in nearly every sound bite the rest of the day. What most failed to point out was the drop to 65.5 in February was a 16-month low. The prices paid component has been steadily dropping since August-2004 when it printed 81.5. Yes, it jumped +8 points in a month but we have to keep that in perspective.
Bonds soared on the jobs numbers with the yield on the ten-year falling to below 4.4% but they were immediately sold off again on the ISM news with ten-year yields spiking to 4.54%. The rise in oil prices intraday and further analysis of the economic reports brought the bond buyers back to the market as equities reversed their opening spike and yields fell back to 4.45% at the close. It was a very rocky session for bond traders and equity traders alike.
Chart of Ten-year Yield - 3-min
The ISM Services number was released accidentally by Business Wire instead of the ISM Manufacturing number at 10:00. Because the news was out the government went ahead and made it official and that supplied even more volatility to the mix. The ISM Services came in at 63.1 compared to the consensus at 60 and the prior month at 59.8. This was an offset to the negative impact of the ISM Manufacturing but the damage was already done. If anything it mitigated the losses for the day but the trend was already in place.
Also spoiling the sentiment was a new release of the Consumer Sentiment showing a drop to 92.6 from 92.9. The drop was not material but it was just one more down trending indicator since its high of 97.1 in December. Rising gasoline prices remain the biggest depressant on sentiment but the slowing jobs picture is sure to depress sentiment even further as the month progresses. Economic news appears to be accelerating to the downside but there is still the occasional bright spot.
Construction Spending slowed again in February with only a +0.4% gain compared to consensus estimates of +0.8% and the +0.6% rise in January. Private construction rose only +0.1% and suggests there is rising concern about economic conditions ahead. Also, rising interest rates should slow construction as the cost of projects rises. Slowing construction rates would also pressure jobs and the downward spiral would continue.
Crude Oil Chart - Daily
The most dramatic economic news for Friday was the jump in oil prices to $57.70 and a new all time high close at $57.20. This two-day jump in oil from the Wednesday low at $52.40 was an impressive +$5 gain. Unleaded gasoline rose to a new all time high at $1.73. I have to admit I was a bit surprised with the jump in oil prices as we moved out of the quarter. I spent most of the day trying to reconcile why oil prices were spiking ahead of the Q2 demand slump when inventories are rising. There was some news about a refinery outage in Venezuela but nothing that should have impacted prices this drastically. I expected a bounce into the end of the quarter as funds tried to appear smart by putting extra cash in energy stocks as the quarter closed. However, I expected a drop in oil once the quarter was over as those with strong oil profits exited ahead of any Q2 demand drop. Next week should be interesting and another pullback would confirm that theory BUT further rises would confirm an even more radical problem.
Further price gains ahead of the Q2 demand slump would confirm that we are farther along in the peak oil scenario than anyone expected and that production from OPEC has NOT been able to keep up with demand. It could prove that OPEC is behind the curve and unable to ramp up production despite their numerous sound bites to the contrary. I still believe that OPEC wants to talk up production potential to keep a lid on any new non-OPEC exploration until it is too late. Once demand does exceed production and oil spikes over $100 a bbl they will be in the drivers seat and can command any price they desire. Any rush to explore/produce then would take 4-6 years to get to market and OPEC will be rolling in cash for that period. A word to the wise, don't believe anything OPEC says and concentrate on actual prices as the real indication of demand and production. Despite the rampant speculation in the market the refiners buy millions of barrels of oil each day and they would not be paying these prices if there was a growing surplus of oil in the system. Oil is a pure supply/demand commodity and with billions of dollars in oil bought daily ANY real surplus would rapidly decrease prices.
I was hoping to see oil return to the 100-day average in Q2 but Friday's spike has put some serious doubt in my expectations. I believe there are quite a few people who also expected the Q2 drop and some may have seen the base built at $54 last week and entered prematurely thinking we were not going lower. Everyone is afraid of missing that rocket ride higher once the demand dip passes and that makes for some nervous buyers. If we are going to see the anticipated decline in prices it should begin next week. I am going to maintain my 100-day average target for at lease another week but I have to admit I am getting nervous as well. If oil continues higher from here it will produce a huge sucking sound as money comes out of the broader market. Q1 is over and fund managers are free to react to any situation and you can bet they want to be on that oil train when it leaves and the broader market will suffer not only from higher oil prices but from negative cash flow into energy equities. The key will be the inventory numbers on Wednesday and another build in inventory levels could weaken the resolve of those willing to buy the top. Goldman Sachs may have negated the fear of a Q2 drop with their $105 price target on oil earlier in the week. Ironically Abby Joseph Cohen, Chief Portfolio Strategist at Goldman, said in late January that over the next 12 months Goldman was expecting oil to average $40 a bbl and this could continue into 2006. She also said they were using $28 a bbl in their pricing model for energy stocks. You think maybe the right hand does not know what the left hand is doing? Maybe somebody at Goldman just finished reading my Oil Crisis report.
One of the biggest drags on the Dow on Friday was AIG with a loss of -4.45. This alone produced nearly a -40 point drop in the Dow. The death sentence card was reinserted in the deck by Spitzer and investors ran for the exits. Spitzer had previously said he would not consider putting the company out of business if the past management left. New allegations suggested that documents have been destroyed and there is growing a pattern of deceit and evidence destruction that restarted the death sentence debate. I had considered buying the dip at $55 thinking the worst was over but the conditions have changed and we could see much lower numbers ahead.
Another drag on the Dow was Wal-Mart, which, finally broke support at $50 and lost -1.12 for the day. This is directly related to higher gas prices and strong pressure on blue-collar workers. This is where higher gas prices produce the largest impact and that impact is felt by the 100-million Wal-Mart shoppers. The WMT decline was hastened by a warning from Best Buy. BBY said earnings would fall to between 27-32 cents for Q1 and analysts were expecting 38 cents. This is not a good sign and another evidence of consumers under pressure with sales of big-ticket items slowing. BBY also said they were phasing out the mail in rebate program because of too many customer complaints. Hoorah! I hate that triple pricing plan where the company bets you will not go to the effort to fill out the form and mail it back. Sometimes the store and the manufacturer both offer rebates, which produces lower headline prices but double the paperwork and hassle. I would say literally 50% of the rebates I have taken the trouble to mail in were declined for one reason or another. Other customers have seen the same results and the Ohio Attorney General sued BBY over failed rebate complaints. BBY fell -3.41 on the news. BBY is also losing market share to its competitors but not the one you would expect. 20% of its volume comes from music sales and that sector is being revolutionized by the Ipod. They are also losing share to WMT and TGT as those low priced music discounters chip away at BBY's core market. The problems with WMT/BBY are not the only problems. The weakness in retailers in general is showing the real impact of high gasoline prices and I do not expect that sector to recover any time soon.
Despite recent warnings, earning estimates for the S&P continue to rise with estimates for Q1 rising to +10.6% growth from last months +9.9% estimate. This should be examined in context. Energy stocks make up 8.5% of the S&P and their earnings growth for Q1 is now estimated at +39% for the quarter. Materials stocks are estimated to produce +50% growth. It does not take a rocket scientist to realize that without those strong gains in energy and materials that the broader S&P is lagging substantially. Without those sectors inflating the overall estimates it could be as little as +5% growth and far from the bullish overall estimates.
It would probably be no shock to readers that Taser was in the news again. This time they warned that Q1 earnings would miss estimates due to negative publicity about their products. The warning caused a break in long-term support at $12 and a drop to $10.42. Now that this support level has broken the move back to the low single digits seems guaranteed. One analyst reporting on the company suggested the market cap for Taser should be more in the $100 million range at two times sales, especially with those sales falling drastically. Currently Taser has a market cap just under $700 million. The bloom is definitely off the rose and this could be an ugly summer for Taser. Over 100 deaths are now blamed on being stunned with a Taser product.
The bears are literally salivating over the economic news this week. They feel we are setting up for the perfect storm in equities and one that will not be easily overcome. They see slowing jobs growth, rising inflation, rising interest rates, rising oil prices, manufacturing sector slowing and earnings growth slowing. The tax benefits that provided an economic boost over the last two years have passed and their impact is fading. I have to admit it is a pretty compelling argument. Economics around the globe are also showing growing pockets of trouble. Japan's Takan report announced Friday, similar to our ISM, came in at 14 compared to estimates of 22, with unemployment up, consumption down, exports weak, production weak, auto sales weak and falling for the 11th time in 14 months, surging commodity prices and falling demand. Sound like any other economy you know?
Faced with all the factors above the Dow traded in a 187-point range on Friday and closed at its lows for the year and only a fraction away from a -100 point loss. Only the bell saved it from closing under critical 10400 support and the outlook for next week is not good. The 200-day average remains at 10378 but it is not typically a strong support level for the Dow. The next material support point is well below at 10000. This is not the position we want to be in as we head into April. However, April is normally kind to the Dow with an average of a +1.9% gain since 1950. It is the best month of the year for the Dow because of its component mix of big-caps. It tends to draw investor money as some of the "sell in May and go away" crowd looks for a dividend haven to park cash while waiting for October. With big caps under pressure I would be really surprised if this April repeated that performance. It would have to rebound to 10701 on April 29th to equal that statistic.
The bright spot in the indexes is actually the Nasdaq. The tech index closed just below 1985 on Friday and well off its highs but it has ceased being the anchor for the markets. The Nasdaq is still holding above the uptrend support from March 2003 at roughly 1975 and it is putting up a valiant fight to cling to the critical 200-day average at 1992. It has traded at or across that average intraday for ten straight days and making a very strong goal line stand. Once that stand breaks along with the 1975 uptrend support the target is 1900 or lower.
SOX Chart - Daily
2000 Chart - Daily
Russell 2000 Chart - Weekly
Helping the Nasdaq is the SOX, which is still stubbornly holding above support at 410. The much stronger uptrend support is still below at 400 so this index is proving to be a pillar of strength in supporting the Nasdaq. However, just as 410 has proven to be interim support the 420 level has proven to be very strong resistance. This battle is likely to continue to play out as we move into the earnings season. Diehard tech buyers feel chips are the leaders of any tech drop or gain and at 400-410 this is support that is attracting bargain hunters. Should 400 fail it could begin a sequence of index failures that eventually drags down the entire market.
The Russell 2000 has fallen back to test support at 605 and each touch over the past three months has found buyers. The Russell is not typically a picture of strength heading into the summer months as the lower liquidity prompts cautious holders to move to the sidelines over the summer doldrums. The Russell high for the first three quarters of 2004 was 606, which it touched three times in the first week of April before plunging to 530 in early May. The Russell could turn into the canary in the coal mine and a break of support at 605 would be a warning that even the bravest bulls have left the building.
Next week is devoid of any material economic reports but there is a flood of Fed
heads taking to the podium including Greenspan. They are sure to make some
comments about the economy, inflation and interest rates that the markets will
key on for direction. The most critical report on the light calendar could be
the oil inventories
on Wednesday. Should inventories build as expected it could
break the back of the current oil spike and give us the entry point we are
looking for. A break in oil would flush billions of dollars out of oil
investments and that money could find a temporary home in equities heading into
the April earnings period. However I believe any equity bounce would be short
lived and we need to brace ourselves for the next leg down. The technicals are
very weak and we are at critical levels. I hate
to keep saying the same thing
but Dow 10400, S&P 1165, Nasdaq 1975, SOX 410, Russell 605 are all critical
support levels and if broken we could see much lower levels on all the indexes
before the summer is over. We tend to keep gravitating to these support levels
but the bulls cannot muster any support from institutional traders. The bull
market is still in energy and commodities and until that market corrects the
broader equity market is left to exist on loose change sloshing
pockets. The brightest piece of trivia I found on Friday came from TrimTabs when
they said -$311 million flowed OUT of energy funds for the week ended on
Wednesday. I am grasping to that tidbit in the hopes it is the leading edge of a
profit-taking wave that will begin next week. With my luck it will be more of a
ripple and one that has already passed. In case I did not make myself clear
today I would not be a buyer of equities without a drastic change in sentiment.
look to short any rebound to 10550-10600, 2015-2020, 1190-1195.
Definitely enter passively and exit aggressively.