The whiplash from the prior week continued to cause grief from traders trying to determine market direction. Alternating moves took us from the highs to the lows and back again with the frequency of a yo-yo. This was the first week this year that produced a triple-triple. That is three days with triple digit moves in the same week. Unfortunately they were not all in the same direction. Monday +169, Thursday -101 and Friday +172. However, even after all that volatility we are still locked into the same trading range that has held us captive since October-5th. I think that range from 1170-1200 is about to break to the upside but we have been here three times before over the last two weeks with a failure each time.
Dow Chart - Daily
Nasdaq Chart - Daily
SPX Chart - Daily
Friday morning started off well with a better than expected Q3 GDP at +3.8%. This was also an improvement over the Q2 level of +3.3%. This was a nice confirmation that the Q2 slump rebounded in Q3 although we do expect to see some confusion appear in the future revisions due to hurricanes. The strong support for the GDP came from consumer spending rising +3.9% and an increase in federal spending at +7.7% also due to the hurricanes. Durable goods rose +10.8%, business investment +6% and equipment and software +8.9%. Residential real estate investment continued to grow at a torrid pace of +8.9% but slowed somewhat from the +10.9% in Q2. Auto sales added +0.5% to the overall GDP number due to the employee pricing program. With that program now over it remains to be seen how the lack of sales will hurt Q4 GDP. Inflation as tracked by the personal consumption expenditures was up +3.7% on an annualized rate. However, the core PCE minus food and energy is still a very tame +1.3% in Q3 and was actually lower than Q2. This gave the markets a boost with the thought that maybe the inflation risk was less than recently suggested.
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The Employment Cost Index rose +0.8% in Q3 and inline with expectations. Wage growth continues to lag price growth and suggests real inflation will remain under control. Price growth typically fails when wages are stagnant but accelerates once wage growth starts to spike. Benefit costs accelerated at +1.3% and well over the +0.8% we saw in Q2. However, these rates are well below the +5% we saw in 2004. It is not that costs are slowing but employers are drawing the line against eating the increases and are passing it on to the workers in some form of benefit reduction. The unadjusted wage growth component has risen +2.3% for the 12 months ended in September and that is the lowest wage growth in 24 years.
Consumer Sentiment fell again to 74.2, -1.2 points from the initial October reading and a -2.7 point drop from September. The expectations component remained nearly flat with the biggest hit coming from a substantial drop in present conditions to 91.2 from 98.1. Consensus estimates had expected a gain in sentiment to something in the 76.5 range. Analysts feel the majority of the drop was due to the drop in the stock market. With gasoline prices falling we should see a rise in sentiment/confidence as the quarter progresses. Any impact from higher natural gas prices on utility bills should not be seen until Q1. The holiday spirit normally increases sentiment but post holiday depression is sure to appear if gas prices do rise as expected.
Monday closes out the quarter with Personal Income and Spending, Chicago PMI and the NAPM-NY reports. Tuesday has the very important ISM for October and Construction Spending. This will give the Fed their final look at the economic health of the country before the FOMC meeting on Tuesday. This meeting will not even be a blip on the radar screen for the markets unless there is a change in the statement to remove the measured pace language. Expectations are for a continued 25-point hike cycle into the January meeting with hikes in November and December. Once into 2006 rate speculation will again take center stage. For now the markets are comfortable with the low inflation numbers in the GDP and the potential for a Fed pause sooner than expected just last week. The flurry of Fedspeak had ratcheted up expectations for rates but today's reports cooled those fears to some extent.
Friday's spotlight on the Lewis Libby scandal sent bonds lower and yields higher with the 10-year yield hitting just over 4.60% intraday with a close at 4.57%. This was the highest yield since March 29th and well over last Friday's close at 4.39%. Strong drops in treasuries the first three days of the week sent yields higher but once resistance at 4.60% was hit the selling eased. As long as yields on the ten-year remain under 5% the market can move higher.
The talking heads on TV were obsessed with the Libby news but the real event taking place right under their noses was the end of October. Monday is technically the last day of the month but for most mutual funds with October year ends Friday was the last trading day. Many funds have October year-ends so tax consequences can be calculated and distributed to investors before the end of the year. This allows investors to plan for any tax bills and not be surprised in January. The last two weeks of volatility, led by the Refco liquidation, was likely due in some part to position rebalancing and tax selling by funds. Those with big gains in stocks like energy or health care may have elected to sell them along with any losers to offset the tax impact. Now that October is over those funds are free to reinvest that cash into other opportunities as November begins. At least that is the conventional wisdom way of thinking. We will see how that plays out.
December Crude Oil Chart - Daily
Like the market oil prices have been trapped in a range between $59 and $64 for nearly the entire month. While support at $59 is strong we are still in a two-month downtrend until conditions in the Gulf return to some semblance of normal. Natural gas prices have weakened to around $13 due to the substantial injection into reserves last week. This is only a temporary event due to the damage in the Gulf. Thirteen gas plants are still offline and 11% of U.S. total gas production is still offline. Even though Wilma did not veer into the Gulf oil patch there was still an evacuation cycle as a precaution. That requires another population cycle as those workers are ferried back out to the rigs. All of this complicates the eventual repair and return to production. The drop in gas prices to $13 is not a positive factor for winter energy bills. Nearly 500 billion cubic feet was injected into storage at this price level or even higher and that is the price homeowners are going to find on their bills. If it suddenly dropped to $10 tomorrow it will not help the winter bills to any great degree. The gas was bought at high numbers and it will heat our homes at those same high numbers. That will not help the stock prices of gas producers today. While $13 is still twice last year's rates and will produce massive profits for those companies the expectation of those rates and profits is already priced into the stocks. Until winter demand begins to draw down stockpiles I believe those stocks are stuck in limbo. It is a historical fact that the current production and pipeline system cannot support the rate of winter consumption. It is only by injecting massive amounts of gas into underground storage in advance of winter that shortages can be avoided. Storage of 3.2 trillion cubic feet is required at the start of November to provide a demand cushion. A prolonged cold snap can put pressure on those reserve levels and cause another spike in prices. Should that occur gas stocks would suddenly find new life. Oil stocks are also in limbo until oil prices break out of their down trend. This may turn out to be a major buying opportunity for both sectors but I would rather wait for the breakout before taking the next plunge. If you look at the chart from 2004 there was a two-month downtrend in Q4 before the explosive gains appeared.
It is only a matter of time before oil demand begins rising again. It was reported on Friday that China's growth for the first nine months of 2005 was +4%. This was on top of the +8% growth in 2004. Growth in China and India may ebb and flow but the trend is inevitably up. Growth around the globe stuttered in September as high oil prices produced sticker shock. Once that shock wears off growth will resume its prior pace. Commodity prices have eased since late September as buying trends slowed and that is good for U.S. manufacturers. Once global growth resumes that trend will reverse.
Oil earnings were the mixed bag we expected with hurricane damage and lost
production putting a crimp in the earnings
of many. Chevron, the largest
operator on the Gulf shelf, still reported a +12% rise in earnings and well
under estimates. CVX said Q4 would be even worse as expenses for recovery and
repair flow through to operations. Chevron was the poster child for the Gulf
disaster with refineries, pipelines, production platforms and drilling rigs all
suffering damage. Other companies reported earnings gains as much as +300% for
the quarter but most were in the +100% range excluding damage claims.
prompted a new round of calls for a reinstatement of the windfall profits tax.
With global production levels flat or falling now is not the time to tax those
profits. Those majors are not going to be spending $1.5 billion for a platform
like Thunder Horse unless it is commercially feasible. Taxing profits is the
same as lowering the price they receive for oil and oil needs to be high to
justify the frantic exploration for the few remaining fields. Oil at $60 will
more exploration effort than oil at $40 and limiting profits reduces the
cash available to pursue that exploration.
The fat lady is singing at Song Airways, the discount carrier created by Delta. The experiment appears not to be working and Delta announced on Friday it was closing Song. The routes and equipment will be folded back into Delta on those routes actually making money. JetBlue and AirTran Holdings rose on the news. Will Ted, the discount carrier spun off by United, be next?
The Jekyll and Hyde markets continue to produce volatility headaches. The close on Friday posted gains for the week on all the indexes except the SOX and NDX but the gain on the Russell was only a pitiful +2 points. Even worse the damage to the NDX was severe as was the lack of a material rebound. The SOX was knocked for a -30 point loss between Wednesdays high and Friday's close on disappointing numbers from numerous chip stocks. There was some dip buying in the SOX but it closed the day still in negative territory. The SOX would be the weakest link in my expectations for a market rebound. The lack of a rebound in the NDX is also troubling.
NDX Chart - 60 min
On Tuesday I suggested it might be time for the rally to start gaining traction as long as we managed to break and hold over the SPX 200-day average at 1200 and resistance at DWC 12000. Both those targets were hit on Wednesday morning but failed to hold more than a few minutes before bears piled on and pushed the markets back to their lows. We have had four major market reversals from the highs over the last ten days. This is NOT a good sign. We can blame it on the Refco liquidation and year end tax selling by funds but the fact remains the bulls were unable to hold the line. The bears performed a remarkable goal line stand at SPX 1200 while the clock ran down on October. I had hoped to be writing this weekend with the markets over that 1200 goal and the worst behind us. In life few things ever work out exactly as expected.
Wilshire 5000 Chart - Weekly
As I ponder next week I am retaining my bullish bias despite my feeling that the fundamentals are still weak. We have seen dozens of earnings misses and even more weak guidance announcements. Still the bulls continue to buy the dip. I don't know if it is just a seasonal thing where everyone just checks their brain at the door and buys October dips or an epidemic of mad cow disease affecting the bulls. I think it is calendar related event more than anything else. Traders are conditioned to believe stocks will go up in November as the only real guarantee in the market. Let's just hope our guarantee has not expired.
That brings me back to next week and the calendar. Since October is over for the funds they are free to put that cash back to work with a long time before they have to report on it again. If they don't go long now and miss a potential Q4 rally investors will jump ship. They are out of choices with the markets knocking on the 1200 door. They can't afford to miss the boat.
The obstacles the bulls have to climb are the October PMI on Monday and ISM on Tuesday. Consensus is for a drop in the PMI from 60.5 to 57.8 and the ISM from 59.4 to 58. While a bigger drop may cause some short-term volatility I believe it will be written off as hurricane damage and the dip bought. Better than expected numbers would of course be very market positive. With the FOMC meeting on Tuesday those numbers take on more of a rate perspective but again, I don't think the Fed is going to rock the boat. If anything I believe their statement will suggest the economy is gaining strength and that would also be market positive.
SPX Chart - 60 min
SPX Chart - 180 min
I am not going to go so far as suggesting we buy any dip on Mon/Tue but it might
be a good idea. I would rather buy a breakout or catch the next cross of 1185 to
the upside from any dip below that level. I don't want to try and call
under 1185 although numbers under 1180 have been doing a good job of attracting
buyers. At the risk of having my crystal ball taken away I think the worst is
over and a real rally is going to appear. That SOX drop back to the July lows
may have been just what we needed to flush some weak tech holders just in time
for the big money to step in. The same goes for the NDX. The complete erasure of
six days of strong gains took the NDX back to 1540 and decent support. Although
rebound was weak it was fund year-end. We have seen my SPX 1185 trigger
number see more traffic than Times Square at rush hour but I continue to honor
the moves. I am cautiously long again on Friday's rebound and will be looking to
add to those positions on a confirmation move over 200-day average at 1200. The
SPX has a strong pattern of higher highs since Oct 13th that places the next
resistance level just over 1210 but I believe the next break over 1200 will pass
easily with the calendar winding down. HOWEVER, the more I look
at the chart the more it looks like a bear flag so caution is still the key word
until a breakout is confirmed. We are running out of days in 2005 and the big
money has got to produce some returns or risk losing business and bonuses. A
break of that 1210 resistance should be the last call before the train leaves
the station. Nobody I know wants to miss it. Enter cautiously on dips but be
ready to act quickly on any breakout.