Option Investor
Market Wrap

Housing Sinks Market

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The strong drop in existing home sales coupled with a sharp rise in homes for sale knocked the Dow and S&P to new six week lows but the bulls bought the dip once again. The rebound rally recovered much of the loss but fear of darkness saw dip buyers taking profits quickly.

Dow Chart - Daily

Nasdaq Chart - 90 min

SPX Chart - Weekly

Existing Home Sales for July fell to 7.16 million from 7.33 million on an annualized basis for a -2.5% drop. Condo sales fell -5% with many high growth areas seeing steeper declines. Housing inventory rose to 2.75 million units, a +2.6% increase and a 4.6 month supply. Condo inventories rose by 23.8% to a 5.3 month supply. The number of condos for sale has increased +67% from the same period last year despite falling prices since January of this year. Bottom line, inventories are up across the board and prices are falling. While this is unsettling to homeowners the analyst community says we are just returning to a more normal environment. Buyers do not have to compete with other bidders and the multiple offer environment is disappearing in most areas. This is not bad news for the economy since it brings prices back into alignment and decreases the inflation pressure of the recent boom. As an example home prices in Las Vegas rose +52% in 2004 but are on track to climb only +12% in 2005. Should this trend continue it could eventually be a problem but with steadily rising demand from first time buyers it has to get a lot worse to be an economic danger. The decline in the headline pace to 7.16 million was still the third highest month on record. That helps put the overall outlook into perspective.


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With mortgage rates rising the urge to buy homes will slow but as long as employment remains strong that urge will still exist. The Monthly Mass Layoffs announced today for the July period saw announced layoffs take a more than 100% jump. Layoff events rose only slightly to 1,249 from 1,175 but the number of workers impacted jumped to 244,216 from 120,0463 in June. June's number was +20,000 over the May levels. The trend is definitely up and rising sharply. This suggests the Jobs report just ten days away could show a weakening employment picture. As shown in the data release among the four census regions, the highest number of initial claims in July due to mass layoffs was in the Midwest (114,158). Transportation equipment manufacturing accounted for over half of the Midwest total. The West had the next largest number of initial claims (52,105), followed by the South (44,995) and the Northeast (32,958). Manufacturing continued to be the biggest loser with 136,210 jobs lost. This is not the type of report economists want to see and a weak jobs report for August could be damaging to the already unstable markets. Yields on the ten-year note fell sharply to 4.19% and a new six-week low. The next Fed meeting is not until Sept-20th but falling yields suggest the outcome is uncertain once again.

The Richmond Fed Manufacturing Survey also released today showed a rebound back into positive territory to +3 from two months at -3. While a return to positive territory is nice the manufacturing sector is still weak in the Richmond region. New orders have risen from -7 in June to only -1 and order backlogs rose from -23 to -11 but both are still in negative territory. This suggests improvement but still well below the peak headline level of 30 attained in March 2004. The Richmond Fed region has been lagging the rest of the country. We will get to see the national number on September 1st with the ISM. The national ISM has rebounded the last two months from a low of 51.4 in May to 56.6 in July. This bounce came at the end of an 18-month decline from the January-04 high of 63.6. Needless to say we were due for a rebound but the question is will it last? High energy prices will likely slow that rebound so the coming release will also be a critical for charting our economic health.

October Crude Chart - Weekly

Energy prices have not declined after a week of calmer action in the oil market. October crude rallied from a morning drop to $64.90 to close at 65.75 in regular trading and is now $66.30 in after hours. Worries about supply continue to push prices higher. The dip over the last week was related more to profit taking ahead of the September contract expiration on Monday than some resolution of the oil problem. Today was the first day of trading for the October contract as the current month. Traders who cleared their desk for the expiration now need to replace those positions with the October contract or later. On the supply side there were continued concerns about the drop in Iraq production due to insurgent attacks. Iraq produced 3.5 mbpd during the oil for food program but is lucky to produce 1 million bbls today. A great day would be 1.5 mbpd but continued attacks will make that a rarity. Youssef Ibrahim of the Strategic Energy Information Group said today that oil could easily reach $75 before year-end as winter demand begins to grow. He just got back from two years in Dubai and said it is really common knowledge in the OPEC community that Saudi Arabia is not only misstating reserves but production has peaked and is declining despite a crash exploration program. I reported this in late 2004 and it is only now being repeated in the mainstream media. There was a very well written article in the New York Times last weekend that explains the coming problem and contrasts the various viewpoints: The Breaking Point

In short there is a real problem and ignoring it will not make it go away. Supply is still restricted from Ecuador and officials claim it will not return to prior levels until sometime in October due to damage done by protestors. There is also the hurricane problem and a new storm heading for the Caribbean, even though it is very weak, brought worries back to oil traders. The worst part of the hurricane season is still ahead. We are just passing time until the next one appears and oil prices show it. In the "what the heck" category we got a sound bite today from Pat Robertson saying Venezuela President Hugo Chavez should be assassinated. Chavez is very anti-American and has said the U.S. is trying to kill him. Robertson was suggesting we oblige him. Chavez is a very loose canon and an eventual problem. Just this week Venezuela opened an office in China to handle their new oil partnership. Exports to China are up +500% over just two years ago. Chavez has said he would love to sell his oil to somebody else and cut off the supply to the U.S. He is trying to put that into practice. I am not going to list the other problems but oil tonight at $66.30 and rising is all the proof you need that higher prices are ahead. Those well positioned will benefit but the majority of U.S. consumers will suffer. This is already being seen in every area of the economy but "experts" continue to downplay the price of oil as just a bubble and something that will go away. I heard one today saying gasoline would be under $2 next month. I think these people are on drugs. Of course they probably think I am as well with my continued "buy the dip" stance on oil. You be the judge. Weekly oil inventories will be out tomorrow morning and are guaranteed to cause volatility.

The government came out with some new gas mileage proposals today that would put our gas-guzzlers on a diet. 60% of new car sales in the U.S. are either trucks or SUVs. For instance vans would see mileage increase from 21 to 23 mpg by 2010. SUV drivers would see a bigger jump from today's 19 mpg average to 28 mpg by 2010. This is a long way from being a law but it will eventually take affect in some form. I have heard the 55 mph national speed limit mentioned several times already this week. For those that don't remember this was a response to the last major oil crisis and a law that was universally hated. I doubt it will return during the Bush term but if the current global demand trend continues the double-nickel or something similar will return.

Wal-Mart was the topic of discussion today as analysts speculated if a more upscale product mix would help broaden its already huge market share. Over 100 million shoppers visit Wal-Mart each month. It did not help the stock price as it closed at a new 52-week low at $46.37. While nearly every retailer was either posting weaker sales or warning for the current quarter, PIR, LZB, WSM to name a few today, Target said sales would be at the high end of estimates. Target is thought to be more upscale than Wal-Mart and is their only real competitor. TGT gave back its early gains on the announcement to end flat for the day. In the retail sector a flat close is something to be proud of this month.

The slowing home sales, rising layoffs, higher gas prices and obvious signs of a slowing consumer took some of the bloom off an already weak market. The Dow dipped to under 10500 at the open but rebounded +60 points by late afternoon. It could not hold its gains and finished with a -50 point loss at 10522. The trend is definitely down and given the bad economics in a historically bad market quarter there is little hope of a sudden recovery. A break under 10500 should find initial support in the 10450 range but a break could seriously damage sentiment once under 10500. My initial target for the coming weeks is still 10250.

The Nasdaq has traded sideways for the last five days and refuses to break the 2135 support. Despite the pause in its downward trend we still have a pattern of lower highs and declining averages. A break under 2135 sets up a retest of support at 2050. Tech stocks saw an early boost by INTC on the RIMM cooperation announcement but both lost some of their gains from Monday. RIMM dipped -73 cents but that was a long way from its +$8 gain over the two prior days. GOOG gained +5 in anticipation of a new product announcement on Wednesday. Something about a space elevator and a new instant messaging service. The SOX continued bucking the downtrend with its fourth day of attempted gains. I say attempted since they were nearly erased both Monday and today with drops at the close. There is still an underlying bid in chips but that support is only able to hold the line against the market weakness.

SPX Chart - Daily with Fibs

The SPX dropped -4 to close at 1218 after dipping under 1215 earlier in the day. We saw a spike to 1225 during Monday's trading so readers should not have had any trouble getting short at that level once again. My recommendation still stands to remain short under 1225 and long over that level. I have been saying it for two months and we seem to return to 1225-1230 almost daily. With oil over $66 in moonlight trading we could see the energy stocks begin to provide support to the S&P once again. The Russell also saw some strong buying intraday when oil began its rebound.

It was a slow day in the markets with barely over 3B shares trading but the internals were definitely negative. While I am still expecting lower lows ahead the rate of decline has been very slow. Mutual funds have only a 3.8% cash position and a level that hasn't been seen since the Nasdaq bubble. Bullish sentiment is very strong despite a decline in fundamentals. That poses a serious question for me. If cash is at multi year lows and fundamentals are slipping ahead of a historically weak period on the calendar then what lies ahead? Funds never want to be the first one in or out of the market. However, once the trend changes the herd stampedes. Since they are almost fully invested there is little cash to buy the dips and Sept/Oct are know for their dips. This suggests we could see a sharp drop if somebody yells fire and triggers the exit alarm. I want to be positioned to buy the historical October dip and you would expect the funds to be anticipating it as well. We are still several weeks ahead of the normal end of quarter portfolio rebalancing but it is coming just as sure as night follows day. The key for the next few weeks is still the same. Enter long positions passively and only when the price comes to you and be ready to exit aggressively if fund managers trigger the exit alarm.

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