It was a relatively quiet day in the market today and the small amount of news today didn't affect it much. The market started with a gap down that was quickly closed in the first hour and then it just sagged for the rest of the day. It was a day where the market simply rested and the weight of gravity took over. When there's no real interest in buying, the normal selling (distributions and other withdrawals for such things as bills to be paid) seems to have the greater influence. There was no real concerted effort to sell off the market today. The net result of today's pullback, including the consolidation over the past couple of days, is that it looks bullish.
We got the unemployment numbers this morning which did not reflect any post-Katrina claims. Initial claims fell 1K to 319K, which was slightly above expectations. The 4-week average rose 2K to 318.5K which reflects an improving job market. There was of course a warning by the Dept. of Labor that we will likely see an upward revision to the jobless claims numbers due to Katrina (10K initial post-Katrina claims were reported received so far). The way I figure it, the only way we won't see a massive increase in initial claims next week is because the people still couldn't get to an unemployment office. The continuing jobless claims fell 5K to 2.59M.
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Following the unemployment numbers was a report about July wholesale inventories which unexpectedly fell -0.1% versus an expected +0.6% gain. This also did not have much of an impact on the market. Sales at wholesalers grew by 0.5%, led by a 7.6% increase in petroleum sales. The inventory-to-sales ratio dropped slightly to 1.18 after hitting 1.19 in June.
Corporate news today included a notice from eBay (EBAY 38.93 -1.53) that it wanted to buy Skype Technologies for $2-3B. This would be a significant shift by eBay into a new technology and away from its core business. This might have been one reason for concern and a drop in eBay's stock price today. Sears Holdings (SHLD 127.81 -7.04) issued a disappointing Q2 earnings report (revenues were $13.19B vs. the $13.69B consensus). Hovnanian Enterprises (HOV 57.49 -4.10), the largest U.S. homebuilder, also issued a downside earnings outlook (FY06 EPS of $8.05-8.40 vs. $8.50 consensus) and they said home price increases were moderating. The Consumer Discretionary group and home builders were hurt by these two announcements.
The techs were helped by National Semiconductor (NSM 26.05 +1.44) after reporting an upbeat fiscal Q1 (Aug) report. It hit a 52-week high today after reporting GAAP earnings of $0.24 per share (consensus $0.21) on revenues of $493.8M (consensus $464.5M). It also reported its intent to buy back $400M of its stock and that it sees sequential Q2 revenue growth of 5%, or approx $518.5M (consensus $488.8M). This was very strong guidance and the tech sector was green most of the day. Texas Instruments (TXN 33.77 +0.47) rallied in anticipation of a positive after-market report, which it gave. Intel (INTC 26.09 +0.43) was also up on the day with similar market expectations. But INTC disappointed by offering a no-change guidance after the bell.
Last week we heard about the negative savings rate and how it indicated the consumer is dipping into savings or selling assets to continue their spending habits. Today it was reported that consumer credit rose "only" $4.4B instead of the expected $11.2B. This is hardly a trend at this point but a continuation of a reduction in consumer debt would be the first step towards restoring a positive savings rate. Of course a reduction in spending would likely cause a slowing in our economy but it would be a necessary healing step to rid our system of excesses.
And last week we heard Fed Governor Bernanke say he would probably do nothing since the storm "wasn't that bad". This week he's saying the effects of Katrina "may be palpable". So he's moved from barely a blip in our economy to a blip now. Say a prayer that he is not the man who will replace Greenspan as the Fed Chairman. The Fed members have been out in force this week talking about the economy, Katrina, inflation and the need for rate increases. They are trying to prepare the market for something but as usual we can't figure out their message. Fed officials say they will see how markets and the economy behave between now and their next meeting on Sept. 20 before deciding what action to take. Prior to Katrina markets had assumed the Fed would raise short-term interest rates for the 11th consecutive time by 0.25% to 3.75%. But now markets see some possibility that the Fed will pause in its rate-increase campaign, although they put the odds for a pause at less than 50%. I'll discuss a little later the quandary the Fed is in over this rate increase business.
The market is clearly vulnerable right now, which I explain below, so it's a matter of identifying when the market will have this figured out. As the bounce off the August low progresses we should soon get an answer as to whether or not it's going to head to new highs or just be a correction to the August decline (meaning the July high could have been the high for the year). After the strong rally from the low on August 30th and the consolidation over the past couple of days let's see what the chart patterns are telling us and I'll do my best to lay out a scenario that I think is playing out (I'm still looking for new annual highs this month).
DOW chart, Daily
After another head fake move below the long term uptrend line, the DOW has bounced strongly with barely a hesitation at the 50 or 200-dma's. After this strong bounce price action looks like it's consolidating the past couple of days. We could see a deeper pullback, especially back to the 20, 50 and 200-dma's in the 10530-10540 area. But regardless, I'm expecting the rally to continue once the pullback is finished so buy any break to new monthly highs.
SPX chart, Daily
Like the DOW, SPX looks strong after a rally back above its 50-dma. Also like the DOW, if we're to get a deeper pullback, watch for support at the 50-dma just under 1223. That's also where we'd have a 38% retracement of the September rally which would be perfectly normal for a correction. It's also possible the pullback is near complete so shorts should be cautious.
SPX chart, 120-min
A little closer view shows where support could be found tomorrow--the broken downtrend line from August 3rd is currently near 1228.50 so watch for potential support there. If that breaks then watch the 1223 area next.
Nasdaq chart, Daily
The COMP has also rallied back above its 50-dma, now at 2149, so if support is not found early tomorrow morning, watch for a pullback to this level for support. The uptrend line from August (not shown on this chart) is near 1257 which is where the first level of support may be found on any continued pullback tomorrow.
SOX index, Daily chart
The choppy rise in the SOX since its August low does not inspire bullish feelings in me. It looks like a bounce waiting to fail at any moment. Longs need to be careful in this index. It's either a correction to the decline from the July high or it's an ending pattern for the final leg up. In either case this index is probably not far from a high. If it manages to rally up to the top of its channel around 492 I would consider it a good short.
VIX index, Weekly chart
We'll keep an eye on the VIX to see if it issues any signals. Right now I'd have to say it's bearish and therefore bullish for equities.
BKX banking index, Daily chart
The banks rallied back above the long term uptrend line but bumped its head on the 50 and 200-dma's. This index has found support and resistance at these moving averages for the past year and hasn't really gone anywhere. However, a failure here after a retest of the 200-dma and a drop again below the uptrend line would look very bearish. That would be a major sell signal. That would also be a huge heads up that the banks are sniffing out trouble in the economy and the broader stock market would likely be not far behind. Katrina, the softening in the housing market, the threat of a yield curve inversion--these are all potential negatives for the financials. Watch this one carefully.
There are many opinions about how Katrina will affect our economy in the short term and for the next year or two. Past major hurricanes have not been kind to our economy. Sam Stovall, chief investment strategist for Standard & Poor's had looked at the 13 costliest hurricanes since 1938, two of which had hit southeast Louisiana just as Katrina did--Betsy in 1965 and Camille in 1969. Looking at the S&P 500 12 months after the storm, the market was down 14% after Betsy and 20% after Camille. I think we could confidently say our country is even more dependent on oil today and that Katrina was far more devastating than Betsy or Camille. History says the equity market may not do that well over the next 12 months, unless of course it's different this time.
After adjusting for inflation we're now being hit with gas prices equivalent to the price spike in the early 1970's so the impact is just as severe now. The poor will obviously feel the impact the most. The percentage of incomes that is spent on energy by those in lower income profiles is already approaching 20%. But the higher costs for gasoline and heating this coming winter could tip many over the edge and spending on anything else could come to a grinding halt. And if rising interest rates further squeeze the homeowners, we could see a major slowing in consumer spending. Without that engine of spending, the economy will surely slow down. The rebuilding efforts in the Gulf states will certainly help alleviate some of that negative impact but that's only a small part of the population and therefore the pluses of rebuilding the devastated areas will likely be swamped by the cut in spending in the rest of the country. And if Americans begin to really worry about their balance sheets and actually start saving again, spending on goods will become that much less. We all know the longer term benefits of higher savings rates but it does spell short term pain for our economy. Then the Fed will likely feel compelled to start lowering interest rates again in an effort, once again, to prime the pump.
The Fed is in a tough spot--inflation is showing itself and the Fed feels the need to fight it with continued interest rate increases. The shock to our economy by Katrina and high energy prices require the Fed to keep the system primed with more money--increasing the M3 money supply. We won't know for another week or two the full extent of how the Fed reacted to the potential economic shock of Katrina but my guess is that they're pumping very large quantities of money (Bernanke's printing press is running flat out) into the system to maintain a higher level of liquidity. This is of course inflationary and it's why I say the Fed is in a tough spot. Many are calling for the Fed to stop rate increases to see how the economy reacts to this shock over the next month or two or three. But Greenspan has already been jawboning the market and dropping stronger hints that he's not happy with the inflated asset bubble, first in equities (which I believe he still feels is way over inflated) and now joined by the housing market. And he fears a housing bubble even more than a stock market bubble.
Without getting into details of the President's Working Group on Financial Markets, otherwise known as the Plunge Protection Team (PPT), this group was established by a special executive order by then President Reagan in 1989. This secretive committee includes the Federal Reserve Chairman, bankers, representatives of the NYSE, Nasdaq and U.S. Treasury Secretary. In documentation that has not been generally made known to the public, the Federal Reserve will coordinate efforts to save the stock market from any severe crash. The reason for this has to do with the belief that the U.S. stock market is vital to not just our own security but for the global markets as well. Greenspan, as head of the Federal Reserve, has made repeated statements in the past that he feels the Fed has a responsibility to control (manipulate some might say) the stock market to prevent a meltdown which would be harmful to national security. The charter of the Working Group is to "protect" the economy and how they do that is the subject of great debate. But back in 1994 when Greenspan was worrying about a bubble beginning to form in the stock market he guided the Fed to increase interest rates in the hopes of cooling the stock market (he should have gone after margin requirements if he was serious but that's for another discussion). The explanation at the time was that they were seeing early signs of inflation. After initially raising rates in February 1994 the stock market dropped 5%. According to transcripts Greenspan told his colleagues in a conference call, "We partially broke the back of an emerging speculation in equities." But the correction was short lived and the stock market continued its rise.
Greenspan continued to worry about a stock market that was clearly on a parabolic trajectory and in 1996 he issued his infamous "irrational exuberance" speech. While the Fed was raising rates to squelch the stock market Greenspan was increasingly concerned about a market that could experience another 1987-style crash. Greenspan was relatively new in his job when he had to deal with the 1987 crash (without the PPT to help him) and he was probably spooked big time by it. He wanted to prevent another occurrence at all costs. As the stock market continued on its parabolic path, it was almost knocked off its path by the near collapse of Long-Term Capital Management in 1998. The PPT sprung into action and thwarted a major banking collapse when LTCM was imploding and this was a prime example of the PPT at work. The action taken right after 9/11 was another time. And now, after a big stock market correction in 2000-2002 and a large recovery since, we have a market that's just as over valued as it was in the late 1990's/2000 (as measured by historical standards such as P/E ratios). In order to fight this equity bubble Greenspan may be trying the same tactic--raise interest rates again in an effort to deflate Bubble II while declaring they're fighting the inflation monster. But now he has an additional problem--the housing market has now joined the party. While the PPT was setup to protect the banking system from a stock market "dislocation" (crash), there's very little they can do about the housing bubble, except to raise interest rates to try to cool off the speculation in that market.
And this is why the Fed is stuck between a rock and a hard place. Even if they feel the economy is going to get a shock because of Katrina, they don't want to risk further inflating the equity and housing bubbles. The consequence of a bubble burst, especially in the housing market, would be far more dramatic and painful, and unstoppable by the Fed or PPT, than the negative impact by Katrina. Even the U.S. Treasury is not big enough to buy up housing inventory. The end game is fairly certain and the Fed is essentially powerless to stop it. The market needs to correct and it's usually an outside shock that kick starts the correction. Katrina, and maybe another 1 or 2 hurricanes coming, have boxed the Fed in and the economy will correct come hell or high water, no pun intended.
The Fed's action at the next FOMC meeting on September 20th should be very telling. If they continue with another rate increase it will speak volumes about what they're really worried about and it won't be the economic impact of Katrina. Instead they will be broadcasting loud and clear that they're more concerned about the equity and housing market bubbles. The two-headed monster than Greenspan helped create will exact revenge on its creator. The rock is the stock/housing market bubble and the hard place is the U.S. economy. The Fed hopes it has an easier time dealing with the hard place and don't want that rock to start rolling down the hill. A slower deterioration of the economy over a year rather than a stock market or housing market collapse is a much better scenario in their minds.
So the Fed members have been coming out of the woodwork to prepare the market. The headlines today included comments from Moskow that the Katrina disruption may be inflationary in the short run and that the national impact is unclear. Yellen was out saying that even with the Katrina risk the economy is doing "pretty well". He said inflation is contained but Katrina raises the upside risk, that higher oil prices may raise core inflation and that we might see slower growth but then a surge from Katrina. Reading between the lines it sounds to me like the Fed is trying to prepare the market for no change in their rate increase policy--that they will continue on their path to higher interest rates. That would be in keeping with their greater concern about the stock market and housing bubbles.
Next week I'll get into how the bond market has figured this all out and why Greenspan has called it a "conundrum" that the bond market is not working with him.
So as stated in the beginning of this report, the stock market, which we're mostly concerned about here, is vulnerable and probably will be for at least another year. History shows our economy is on the verge of a slow down and of course the stock market will reflect that before we see it in the economy. We're watching the market very closely right now to see if the bounce off the August low is going to amount to much. Even if we get a new high, and I'll say especially if we get a new high, this market is near being done. Steak tartar for everyone soon.
Oil chart, August contract, Daily
The intersection of the two up-channels just above $70 proved too much, or certainly was a good signal that oil's rally was topping out, and this was before Katrina. Oil pulled back sharply and as expected got a bounce off its 50-dma and uptrend line from May (and the mid-line of the longer term up-channel), both near $63. If the next bounce is corrective (3-wave, overlapping highs and lows), look for lower lows in oil. If $63 should break after bouncing, I'd look for lower support at the longer term uptrend line approaching $58.
Crude oil inventory numbers were released in the afternoon and showed higher numbers than had been expected. Inventories (excluding those in the Strategic Petroleum Reserve) fell by 6.4M barrels from the previous week. At 315.0M barrels, U.S. crude oil inventories remain well above the upper end of the average range for this time of year. Gasoline inventories declined by 4.3M barrels last week, putting them below the bottom end of the average range. Distillate fuel inventories decreased by 0.8M barrels last week, and are above the upper end of the average range for this time of year. Total commercial petroleum inventories dropped by 14.9M barrels last week, and are near the upper end of the average range for this time of year. And lastly, U.S. natural gas stocks were reported up 36B cubic feet last week. All of these numbers will be of interest to the market over the next few weeks.
Jeff Rubin, chief economist and strategist at the CIBC World Markets, raised his forecast for West Texas Intermediate crude oil for 2006 to an average price of $84 a barrel. He said oil prices will average $93 a barrel in 2007 and that prices are expected to reach or exceed $100 a barrel by the fourth quarter of 2007. His reasoning for the price increases, other than growing demand, is that the devastation to oil fields and oil industry infrastructure from Hurricane Katrina will cut current and future production in the Gulf of Mexico. Planned expansion of production in the Gulf over the next two years is likely to be cut by half (although there's renewed pressure to drill off the west coast of Florida) which he says will reduce future supply by nearly 300,000 barrels a day. Meanwhile, production has been stagnant in Russia and capacity is "tapped out" among OPEC nations, the study said. I'm thinking this forecast is based on future economic growth projections so if instead we get a slowdown then the price of oil may not follow this upward trajectory. Stay tuned...
Oil Index chart, Daily
Even with a sharp pullback in the price of oil, the oil stocks have stayed strong. In fact the price pattern looks like it could use one more high before considering it topped out. If the broader market rallies further, these stocks will likely join in.
Transportation Index chart, TRAN, Daily
I would have expected a sharp drop in oil to help the Trannies but they're still languishing near its 50 and 200-dma's. This does not look bullish for this index. If it's to bounce as depicted on this chart, it needs to get going now. Any further drop from here should find support at the uptrend line near 3580 and it would significantly lessen the chance that this index will see new highs. In other words, this index may have already topped out back in March. In that case it would then be further evidence of the intra-market divergences typically seen at market tops.
U.S. Home Construction Index chart, DJUSHB, Daily
After the strong bounce off its uptrend line, the housing index is struggling to get back up to its 50-dma. The 1025 area is where I would consider the short side for stocks in this index. If it's to rally a little further than that, the 62% retracement level of 1047 would be my next target for resistance. It's even possible that the corrective bounce is finished although that's not the way I'm leaning here.
U.S. Dollar chart, Daily
The U.S. dollar looks like it's going to make an attempt to bounce back up to its broken 200-dma. With the 50-dma and downtrend line not much above that I think the dollar has tough resistance just overhead. The price pattern looks like it will head lower once the current bounce is finished.
Gold chart, August contract, Daily
After an impulsive rally off the July low and only a 3-wave pullback to the August low, a new high in gold was expected. That happened yesterday and this should have higher to go. I'm bullish gold here.
Tomorrow's economic reports include the following:
After the close, TXN raised Q3 sales targets to 3.4-3.62B versus prior 3.29-3.56B and expects to earn .36-.38, up from .31-.35, for the quarter. Its share price jumped after the report and settled +0.43 higher than its 16:00 closing price. INTC disappointed by narrowing its Q3 sales forecast to 9.8-10.0B in sales versus prior 9.6-10.2B. The average of each of those ranges is 9.9B so in actuality there was no change to their sales forecast. Their expected gross margin was left unchanged at 60%. Investors don't like to hear "no change" and weren't happy so the stock was sold off after the close, dropping it -0.22 from its 16:00 closing price. The after-market futures showed little reaction to the reports of the dynamic duo.
Biogen Idec (BIIB 42.44 -0.03) said after the closing bell Thursday it would eliminate 650 jobs, representing 17% of the biotechnology company's work force. The move is intended to reduce annual operating expenses by $200 million to $300M.
Yellow Roadway Corp. (YELL 46.01 -0.55) reported after the bell that it is lowering its Q3 earnings forecast to $1.40-1.45 per share from $1.60-1.65 per share. The company cited Hurricane Katrina as one reason for the lowered forecast. The company estimated the storm's impact at 5 cents a share in the third quarter. My guess is that there will be many companies jumping on the Katrina bandwagon to explain their downgrades.
Consumer Staples was weak, which was hurt by a -9.0% drop in Coca-Cola Enterprises (CCE 19.99 -2.11) after reporting that their Q3 earnings would miss analysts' forecasts of $$0.51 due to weaker-than-expected shipments in Europe. Altria Group (MO 72.54 +1.48) was up on the day after Morgan Stanley reiterated an Overweight rating on the tobacco firm and raised Altria's break-up valuation to $105 per share (from $91).
Other sector action showed more red than green with the green sectors led by the gold and silver index, the SOX, airlines and technology. The losers were led by the retailers, the Trannies, biotechs and financials.
The bottom line for tomorrow is that we could continue to consolidate or even pull back a little further. But the larger price pattern shows that the current consolidation should be followed by another rally leg. Therefore the short side should be the riskier side. Scalp 'em short and look to buy the dip especially if we rally to a new high for the month--I have an upside target for SPX at 1263-1267 so there's some potential there for a long. Until I see evidence of topping or impulsive moves to the downside, I'm looking to buy the dips. But even playing the long side needs extra caution right now. If we start driving lower you definitely don't want to be stepping in front of that train. We should be getting close to a potential major high for the market, especially if we're not going to make a new high. Surprises from here will likely be nasty ones to the downside. We could get some flare-ups as shorts run for cover, which would be a nasty surprise if you're short, but with a vulnerable market there may be many fund managers with their finger hovering over the sell button. You don't want to get caught in a no-bid situation wondering why your stop orders are not getting hit. These are tough times right now so continue to trade lightly, take your profits quickly and keep making base hits. The home runs will come later.