September broke with the historical norm and the Dow finished with a +86 point gain for the month. September has the reputation as the worst month of the year for the markets but it did not come true this year despite a flurry of negative events. Since 1970 the Dow has only posted a gain for the month ten times in those 35 years. The last time the Dow posted a gain in September was 1998. Despite the technical win the month was not without its problems and October, another month known for volatility lies ahead.
Dow Chart - Daily
Nasdaq Chart - Daily
SPX Chart - Daily
SPX Chart - Weekly
Friday produced some economic surprises in both directions beginning with a strong jump in the Chicago PMI to 60.5 for September from August's 49.2. This was the largest jump in 20 years. You may remember that the August reading was a very sharp drop from July's 63.5 and this rebound erased almost all of that August drop. The PMI has been very volatile of late and this zigzag movement makes the number less reliable as a real indicator of growth. However, looking at the components there were some real changes in sentiment. New orders jumped from 46.5 to 63.4 and there was also a large jump in production and deliveries. On the downside there was a drop in employment and inventories and prices paid jumped sharply to a new cycle high at 76.3 from 62.9 in August. Higher prices are working their way through the supply chain and the Fed will be watching. We now have a disparity in these regional reports with the Chicago PMI moving higher along with the Kansas City Survey and the Richmond Fed Survey. Moving sharply in the opposite direction was the Philly Fed and the Empire State Survey. These are more closely followed than the group showing gains. With higher energy prices and prices pushed higher by Katrina/Rita now flowing through the system the Fed is likely to continue raising rates and we are seeing an increased potential for more aggressive hikes.
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The NY-NAPM also released on Friday continued to rise and set a new high at 349.7. While the current conditions component remained flat the six-month expectations rose to 70 from 50. The rebound from the 9/11 disaster continues to move New York sentiment higher but it can't be used as an indicator of sentiment on a national level.
Personal Income and Spending for August was released on Friday and it was not pretty. Income fell -0.1% but it was mostly attributed to the impact of Katrina. The really ugly numbers were spending which fell -0.5% and the personal savings rate which fell -0.7%. The savings rate was actually an improvement from the -1.1% drop in July. The slight rebound came from a drop in auto sales that left more money in consumer accounts. That is not necessarily a positive event given the need for auto sales to help support the economy. Various auto analysts have mentioned recently that auto sales fell off the cliff after Labor Day and we should be seeing hard evidence of that fact soon. The drop in auto sales in this report was the largest drop in over three years. The negative savings rate is at levels representing all time lows and a serious problem for the economy. When consumers have no savings they are less able to withstand downturns in the economic cycles where unemployment and higher interest rates produce drag on consumer spending. Add in the impact of high energy prices and the consumer stress is increasing.
The final reading of Consumer Sentiment was released on Friday and there was no snap back from the sharp decline to 76.9 posted earlier in the month. The final number duplicated the initial reading with the expectations component falling to 63.3 from 76.9 in August. Consumers are suffering sticker shock with every fill-up and once the winter heating bills arrive it will be even worse. Their outlook for the next six months is growing increasingly dimmer.
In the markets on Friday the main focus was still energy with oil output from the Gulf still 98% offline according to the Minerals Management Service. 79.4% of gas production is still offline as well as 18% of our refining capacity. Despite these numbers the price of oil remained confined to the $66 range due to many converging factors. The current month contracts in Unleaded Gas and Heating Oil ceased trading on Friday with Natural Gas still trying to find neutral after its contract change on Wednesday. Add in the end of month and quarter and the markets were stuck in a twilight zone of conflicting pressures.
On Thursday we saw three buy programs that provided +120 points of lift to the Dow and triggered short covering on the S&P that took it back to 1228 and that is exactly where it closed on Friday. The buy programs were likely funds doing some month/quarter end window dressing and despite the +80 Dow gain for the day it was a very wimpy excuse for quarter end buying. Personally I am surprised it was able to lift the market at all given the historical precedence for a down week at the end of September. But, last week is now history and we are faced with the first week of October volatility just ahead.
Oil was basically flat for the last four days but the market was unable to capitalize on the event. Were it not for Thursday's end of quarter window dressing programs this September would have just been one more negative notch on the losing side of the historical calendar. Next week I seriously doubt oil will be flat and the cold front crossing the country this weekend will have consumers brushing the dust off the thermostat to ward off the sudden chill. That will start the consumption cycle for winter and natural gas demand will begin to increase. Typically the cold weather does not really begin until Halloween but in the futures market that speculation should begin in earnest next week. Vail Colorado received five inches of snow this week to usher in the change to winter weather. We have new front month contracts on all the energy fronts, Nat Gas, UL Gas and Heating Oil, Crude oil was already trading on November, and the weak pullback on Friday's close should provide an entry point for next week.
We had more negative news on the energy front and it is going to keep getting worse. American Airlines announced on Friday they were going to cut back on flights due to high fuel prices. Jet fuel is up +39% this qtr and +91% for the year and with 18% of our refineries offline it is going higher. Continental Airlines quickly followed suit and said it was reviewing its schedule for routes that could be cut. Continental also said it was raising ticket prices +$10 on every flight to defray fuel costs. United said it was not making any changes at this time. I warned about the airlines cutting flights/routes last November in my Oil Crisis report and this is only the tip of the iceberg. As oil prices continue to rise we will see flight cuts becoming a more routine event. While this is unfortunate for consumers it is good for airlines as it concentrates customers into existing flights and fills up planes. Airlines will save money by not flying marginal routes and will make money from having all flights full. Ticket prices will continue to rise and eventually consumers will not be able to afford the tickets but that is still a couple years away.
Airlines should get some relief from rising jet fuel prices next week as some of the refineries knocked out by Rita begin to come back online. Exxon said it was restarting one refinery now and Baytown would restart next week. Shell said it would have its refinery back online in a matter of days. Entergy said it would have power back online to most refineries in the next 7-10 days and that will allow them to begin restarting. However, not all the news was good. BP said its Texas City refinery would be offline for another 6-8 weeks. Valero and Total said their Port Arthur refineries would not be back online for another 2-4 weeks. The pipelines onshore are mostly back in business but the Centennial is still closed and those open are working at reduced capacity with limited product to fill them. The longer the refineries are offline the more expensive refined products are going to get. We have been importing millions of barrels of gasoline from IEA members as part of their emergency program but that is almost over. We also heard on Friday that France's largest refinery was closed due to a strike and that will put another crimp the global supply.
With all the energy liquids and gases already at or very near new highs this may be one Christmas where a lump of coal in your stocking is the preferred gift. Every boost in natural gas prices makes coal more valuable and the prospect of gas shortages is increasing the demand for backup supplies of coal. My favorite in this sector is Peabody Energy (BTU). Put BTU in your portfolio and mix in a little gas from ECA, CHK, SWN, EOG or my favorite UPL and you will have an explosive mixture to keep your portfolio warm for the cold weather ahead. Oil prices may not rally past $70 until later this year, if at all, because the lack of refining capacity is offsetting the lack of oil production in the gulf. Buy oil on the dips but buy coal and gas on every blink.
November Crude Chart - Daily
December Natural Gas Chart - Daily
December Heating Oil Chart - Daily
On the tech side the biggest news on Friday was better than expected earnings from Micron. They posted a gain of +7 cents when analysts had expected a loss of -8 cents. Micron jumped over a buck to $13.30 on volume of more than 46 million shares. The buzz was due to the jump in demand for NAND flash memory chips to store data, songs, photos and videos in consumer electronic devices. Micron said NAND sales were five times higher than the prior period. High capacity NAND chips are taking the place of disk drives in things like the iPod Nano. The Micron news pushed the SOX to a +9 point gain and back to resistance at 475. This bounce erased the final portion of a two-week decline that knocked the SOX back to just above 450.
Another sector riding high on Friday was the homebuilders. You just can't pop the homebuilder bubble for long before they come roaring back. I am sure a lot of the rebound was on profit taking by shorts and buying from funds for their end of quarter statements. After the bell the sector got another indirect lift after Lennar (LEN) was named to replace Gillette in the S&P-500. LEN jumped about +$2 in after hours trading. Google had been expected to replace Gillette but was snubbed once again by the S&P steering committee. GOOG fell -$4 in after hours after gaining +6.84 during regular trading. I would expect GOOG to drift even lower on Monday. Chevron (CVX) was named to replace Gillette in the S&P-100 but very few funds index to the OEX.
The end of quarter buying pushed the Dow over resistance at 10500-10550 and turned a potential lower high formation into one that looks suspiciously like an uptrend from consolidation. It is far too soon to tell but crossing the initial 10500 resistance barrier was a big plus even if it came on the heels of three buy programs. The next resistance band is 10600-10650 and we are heading into October, a month known for hosting bottoms.
The Nasdaq chart also shows a surprising break from consolidation and a rally to 2150 at the close. The next resistance level is 2160 followed by 2185. The SOX rally on the Micron news was a very big factor in the Nasdaq bounce and it will be interesting to see if that buying will continue on Monday.
The S&P rose on Thursday's window dressing programs to 1228 and failed to move any higher on Friday despite the gains in the Dow and the Nasdaq. This is troubling to the rally scenario and suggests the broader market may not be as bullish as the Nasdaq chips and Dow appear. I was using SPX 1225 as my long/short indicator and when the S&P failed to move higher on Friday I reinstituted my market short at the close. I was prepared to go long over 1225 even if I was not convinced in the rally but the lack of any material move over that level kept my bias to the short side. The lack of conviction over 1225 made me rethink my target given the end of quarter buying and the potential for some window undressing on Monday. Strong resistance waits at 1235-1240. I am still not convinced we are not going to see one more dip before any Q4 rally.
The economic reports next week include the ISM on Monday and the September Jobs Report on Friday. Both are critical to the economic picture but I think the ISM is the key. Everyone knows there were hundreds of thousands of jobs lost by Katrina and the report will just be confirmation. However the ISM is a better check of national economic health. We have seen conflicting regional numbers and the national ISM will put those conflicts to rest. For next week I would be cautious about picking a direction and let the market decide for you. With 98% of Gulf oil production and 79.4% of gas production still shut in there is a very good chance energy prices will rise again next week. Energy stocks, primarily natural gas stocks due to the lack of a strategic gas reserve or material imports, should be a sure bet. They were all up strongly last week and gave back very little ground on Friday. That relative strength in the face of potential end of quarter profit taking was confirmation for me. However, there is always the potential for profit taking on Monday. Funds wanting to appear smart could have kept them in the portfolio over the quarter end but plan on taking profits first thing next week. Funds typically reshuffle positions in October once Q3 closes and make a last set of adjustments before any end of year rally. Taking profits in energy now could guarantee them a positive return for the year and guarantee bonuses. I think they would be passing up even more profits in Q4 but it is a numbers game and putting profits on the board keeps investors from switching funds. If we are going to see this type of a rotation it should happen almost immediately and represents a buying opportunity for the rest of us. As always, remember to enter passively and exit aggressively and definitely don't get married to your positions or your bias.