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All About The Fed

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Thank the Fed for this weeks rally. Actually thank those traders betting the Fed is very close to its last hike. The rally started with the FOMC minutes on Tuesday and just when weakness was beginning to appear later in the week the weak employment report reenergized the buyers and pushed the indexes to a new high. You can also add Google to your list of market movers after the stock soared +56 points only two weeks after being added to the Nasdaq-100 index. As the 3rd largest Nasdaq weighted stock this +56 point gain was the strong push necessary to send the Nasdaq to new highs.

SPX Chart - Weekly

Dow Chart - Weekly

Russell-2000 Chart - weekly

Nasdaq Chart - weekly

Leading the markets on Friday was a weaker than expected growth in the employment market for December. The headline number at +108,000 was half the consensus estimate of +215,000 and only half of the previously reported +215,000 seen in November. However, there was some good news with the prior November number being revised higher to +305,000. This upward revision nearly erased the shortfall from December. The economy created 2.019 million jobs in 2005, which was slightly lower than the 2.194 million created in 2004 but still a decent rate for a recovery this old. Moodys expects employment to continue at +200K per month for the first half of 2006. The unemployment rate fell to 4.9% and a cycle low but it was mostly due to a drop in the total labor force as more blacks and teenagers dropped out of the labor pool. That type of comment always amazes me. What it really means is their unemployment benefits expired and they fell off the official rolls not that they just decided to drop out of the workforce. For whatever the reason it provides a strong headline for Saturday's papers of only 4.9% unemployment. Investors will not see in the Saturday headline that the BLS is still having trouble accounting for employment in the hurricane areas. They are using alternate methods to estimate jobs in the hurricane area and jobs impacted by workers moving out of the area. It is possible the numbers could have been higher but we are a long way from erasing that impact to the accounting process.

While the new jobs numbers were weaker than expected the benefit to the market came from the expectations for the Fed. The lower jobs coupled with the FOMC minutes from Tuesday pushed rate expectations to "one and done" at the January-31st meeting. While it is just speculation it would appear the Fed is on track to raise rates at Greenspan's last meeting and then move to the sidelines. This eases worries that the Fed will overshoot and force the economy into a recession.

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Historically the best time to invest in the market is typically just before the last rate increase. Despite the official consensus still calling for two more hikes the unofficial consensus is a "hope" that January will be the end of the line. With the release of the FOMC minutes on Tuesday this hope surged. The FOMC minutes stated "views differed on how much further tightening might be required" and "that policy decisions going forward would depend to an increased extent on the implications of incoming economic data for future growth and inflation." They also said "The federal funds rate had been boosted substantially, and, in the view of some members, it was now likely within a broad range of values that might turn out to be consistent with output remaining close to potential." This dissention among the members about the need for future hikes would probably hinge on future economic reports. The smaller than expected jobs report and the drop in the ISM to 54.2 from 58.1 suggested that the Fed would be looking at weaker economics at their Jan-31st meeting and they would not be able to maintain a consensus to raise rates after January. This is a huge leap of faith since the March-28th meeting is nearly three months away and there will be three more sets of all the economic numbers before that meeting. That did not keep some investors from taking another leap into the market.

The market on Tuesday was a perfect example of another big short squeeze as those investors leaped into the market. After loading up on short positions for most of the prior week the shorts were surprised by the reaction to the FOMC minutes and the race was on. After the monster short squeeze that pushed the SPX back to December resistance at 1275 the SPX went nowhere for two days as shorts tried to reenter at that resistance in anticipation of a roll over and a resumption of the prior trend. Friday's reaction to the Jobs report hammered these new positions and triggered buy stops again producing yet another squeeze higher. Needless to say the shorts are going to be very leery about trying to fight the trend again next week.

SPX Chart - 30 min

SPX Chart - 10 min

Google had an outstanding week tacking on +56 points from the Dec-30th close at 414.50 to Friday's intraday high at 470.50. This +56 point gain helped push the Nasdaq to a new closing high and helped erase weakness in Dell and Microsoft. Much of this gain was related to higher targets as rumors of new projects are leaked from Google's staff. Goldman Sachs raised their target to $500 but it was overshadowed by Piper Jaffray raising their target to $600. Both were left in the dust by Mark Stahlman at Caris & Company who said Google could hit $2000 within five years. He based that prediction on a sharp increase in revenue as Google's new projects began to generate additional revenue. Google is expected to produce $9B in revenue in 2006 but Mark said it could ramp to $100B within five years. Increased offerings on the web, some on a subscription basis, as well as new forays into insurance, finance, healthcare, software, TV and even hardware are expected. After the close on Friday Google announced a new video download service where suppliers can name their price contrary to the required $1.99 price from Apple. They announced that they had already signed up numerous content suppliers like Sony, CBS and the NBA. The NBA will be offering games on 24hr delay for $3.95. CBS will be offering nearly its entire video library including things like episodes of "I Love Lucy", "Twilight Zone" and the "Brady Bunch" as well as current content. Sony BMG will be offering music videos and Getty images will be offering historic videos from the past. These are just a sample of the tens of thousands of titles to be offered through Google. Google will get a commission of 30% for each download. Google claims they have 2.6 million viewers already registered to the service while they tested it over the last six months, mostly with home movies. You can expect that number to soar with real content given the estimated two billion cell phones worldwide. Add in the Video iPod and numerous other video capable devices including laptops and regular PCs and the market is virtually unlimited. Google jumped +$14 on Friday and has added nearly +$20 billion in market cap this week alone pushing it to $137 billion the 3rd largest Nasdaq company behind MSFT $286B and Intel at $158B. It has already surpassed Cisco at $115B, Dell $72B, QCOM $77B and YHOO at $61B. If you believe the hype the 2008 $600 LEAPS are "only" $71.70 per share. I believe a better deal would be to buy the stock and sell the LEAPS as a covered call. That would net you $668.40 by Jan-2008 ($135+68=$213 total profit) if GOOG actually hit $600.

Comparison Chart - Google, SOX, Nasdaq Compx

The gains pushed the index over 2300 for the first time since May-2001. The combination of a strong SOX and new 52-week highs in Google, AAPL, SNDK, FLSH, BEAS, CELG, BRCM, QCOM, NVDA, YHOO and more than 210 other stocks powered the index much higher on a relative basis than the other indexes excluding the SOX. Note the comparison chart of the major indexes below.

Comparison Chart - Compx, NYSE, SPX, Dow

Needless to say the short squeeze on Tuesday caught me off guard. I was short and expecting a big week to the downside after Santa had a sleigh wreck on his way to Wall Street. The best laid plans of mice and men sometimes go astray. I know I was in good company given the strength of the squeeze. Initially I did what every other short did and that was reenter at 1275 on Wednesday. When the SPX failed to roll over and break 1270 resistance for two days straight I began to reconsider the error of my ways.

As I reviewed the markets after Friday's close I had to determine if our chances were for further highs or a failure of this spike. The internals were very strong on Friday and it is just possible that an old fashioned January rally is underway. Four days of trading does not make a trend, especially when two of those four days were flat. Everybody is focused on the first five days indicator and after Friday it would take a major crash on Monday to turn this indicator negative. According to the indicator the market direction for the first five days of the year will be the market direction for the year. That is probably the least reliable indicator but there is one very reliable January indicator that deserves mention. According to the Stock Traders Almanac every down January since 1953 has preceded a bad year in the markets. The average loss was -13% in the S&P. January is the third best month for the markets behind Nov and Dec since 1950 and averages a +1.5% gain. So far the S&P has rallied +37 points or +2.9% but the month is still young.

The only real weakness I could find last week was in the Transports. After the Tuesday short squeeze the index barely held its ground on Wednesday and posted losses on Thr/Fri. Part of this weakness was due to the unbelievable spike in oil prices. I am sure more than a little weakness was due to the new highs in the index set only four days before year-end. Compared to the transportation losses in prior Januaries this weakness was just a blip in the trend despite the plunge to 4100 on Tuesday. That was -200 points off the prior weeks high. I am far from bullish on the transports and without the transports the Dow rally could be brief.

The most bullish indicator over the last week has been the Russell-2000. This is the index favored by mutual funds and the place where they put their year-end retirement contributions when they are bullish on the market. This index never showed any weakness the entire week other than an opening dip on Tuesday. That dip was bought and those slow on they trigger found themselves chasing it higher the rest of the week. It closed at a new all time high of 700 and well over prior resistance of 692 and well off the lows for the week at 667. This is very good evidence of funds entering the market and not waiting for a January dip. The Russell was far stronger than the Dow and SPX.

Russell Comparison Chart

SOX Chart - Weekly

The SOX was the single strongest index gaining +8.36% for the week. This was also a bull market indicator since gains in chips are normally a prelude to gains in other tech stocks. The logic is supposed to work like this. Manufacturers order new chips for new products. Delivery of those chips occurs 3-6 months before the products hit the shelves. In theory buying chip stocks ahead of this manufacturing wave positions you to be ahead of the street by six months or more. That theory works well if in fact a new manufacturing wave is coming. Based on the thousands of new products at the Consumer Electronics Show in Vegas this week we should be right at the beginning of a new chip wave. Whether investors actually did their homework or just bought blind in hopes of a chip rally the result was the same. The SOX rebounded +8.36% compared to the Nasdaq at +4.55%, Dow +1.63%, SPX +2.98%, Russell +3.89% and the Transports at +0.43%. In fact the Dow, Nasdaq and the Russell gained more on a percentage basis in the last four days than all of last year combined. Performance in 2005 from the Dow was -0.6%, Nasdaq +1.4% and Russell +3.3%.

Crude Oil Chart - Weekly

Probably the biggest surprise of the week is the bounce in crude oil prices back to more than $64 from last weeks $57.30 low. There has not been any material change in fundamentals with only a drop of -1mb from inventory last week. That drop in oil was offset by a sharp increase in gasoline and distillates showing that the oil was refined. The report was expected to knock oil prices back to the prior weeks levels but instead they continued to rise. The gains were blamed on a massive influx of mutual fund money and reinvestment by hedge funds after cashing out to collect 2005 performance commissions the prior week. Friday's close at $64.20 was better than a two month high and prices are not showing any signs of fading. One analyst said it was in expectation of shortages when driving season begins in four months. While I agree with the potential for tight summer supply it is not normal for traders to take long positions ahead of the March supply glut. We do have a likely OPEC production cut late this month but again, this is too far in advance of the actual cut, probably March 1st, since a lead-time is always given. If it is just fund money chasing a repeat of 2005 gains this bounce is likely to end badly. Warm weather continues to blanket the U.S. with temperatures in the Rockies nearing 70s for the last two weeks with a forecast of another warm week ahead. This has hammered gas prices back to $9.65 and well off the $15.78 high back on Dec-13th when cold weather was raging.

We are still a week ahead of the start of the January earnings cycle. We will see some earnings next week from AA, DNA, MTG and about 40 others but the main flurry does not begin until Jan-17th when Intel and IBM kick it off with a bang. We have not heard much about earnings but that will change beginning next week as analysts dust off their outlooks and try to get some face time on stock TV. That face time will likely give some stocks a little more push as we saw from upgrades on AFL, BEAS and CRM on Friday. Positive upgrades in a volatile market tend to generate strong responses. As analysts upgrade their forecasts it could continue to add fuel to this market.

I hesitate to publish my thoughts about the market for next week after being blindsided by Tuesday's short squeeze. Had the SPX failed to break 1275 as it appeared it would on Wed/Thr I would have been content to say short the bounce again and try again. However, if you remember my commentaries in the past I have always been bullish over 1275. I believe that is the make or break level for sentiment. Under 1275 and the markets are deemed to be stuck in the ever present trading range and money on the sidelines is content to watch the battle from afar. Over 1275 and that money can't afford to watch and must get involved or risk losing out on potentially strong gains if the stalemate at 1275 has really broken to the upside. I believe that jobs spike on Friday tipped the scales in favor of the bulls and we could be going higher. However, the influx of year-end contribution money should be about over and the markets will have to exist on their own momentum now rather than those year-end funds. This could produce a hollow thud as markets crash back to earth next week but I doubt they will retrace much. Once the bull has broken free it is hard to convince investors it was just a head fake. After strong gains like we saw last week there is always the chance for profit taking to appear but I have been caught flat-footed while waiting for it far too many times to suggest buyers wait on the sidelines. Breakout rallies tend to feed on themselves and I would hate to miss that run.

Instead of a hard and fast call for next week we need to revert to the tried and true pivot point of 1275 for guidance. Actually I am going to use 1270 as first support under the 1275 breakout. As long as we remain above 1270 I will remain bullish and looking for further gains to the upside. A break under 1270 could have the bears coming back for another feast but I suspect it will be only crumbs and not a buffet. I would hate to see this breakout turn into a repeat of 2003 where the first nine days were bullish followed by two months of declines with the SPX losing more than -130 points. January 2002 had four days of gains to a new high only to be followed by 33 days of weakness and -102 SPX points. Both years started out with a bang only to fall flat once the year-end contributions slowed. This year has an added factor that could prevent those declines. That is the anticipation of an end to the Fed rate hikes. That is the prime mover at present and takes precedence over nearly every other factor. Even bad economics get a pass since they would only hasten the end to rate hikes. The only bad news would be good news with a sudden spike in economic activity that puts the Fed back in hike mode by the Jan-31st Fed meeting. Until conditions change buy the dips above 1270 and short a break below that level.
 

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