The entire day, actually yesterday and today, was put on hold while we waited for the FOMC announcement. It's not as if we all didn't know that the Fed was going to raise their discount rate another 0.25%, which they did, but what the market wanted to hear was what wording changes there would be to provide some hints as to further Fed action. The market finished slightly down on the day but then after the bell Google's (GOOG) earnings came out and to say investors were disappointed is probably a gross understatement. After-hours futures show the disappointment as well, but not as bad as the GOOG stock itself. More on that later. I (Keene Little) will be filling in for Jim again tonight (all hate mail should continue to go to him). He'll be back on duty next week.
In a continuation from yesterday's very quiet trading day, this morning started off quietly as well. The three economic reports, the Employment Cost Index, Chicago PMI and Consumer Confidence, barely registered a ripple in this morning's prices. The ECI for Q4 came in at +0.8%, the same as Q3 and was slightly less than the +0.9% expected. The ECI for all of 2005 increased +3.1%, the lowest since the +2.9% gain in 1996. As a comparison, the ECI increased +3.7% in 2004. The Fed watches this number carefully since they're concerned about inflation from an increase in the ECI. But real, inflation-adjusted, compensation costs fell -0.3% in 2005, the first decline since 1996. Real wages dropped -0.8% for the 2nd straight year in 2005. Inflation-adjusted benefit costs increased 1.1% for the year.
My take on these ECI numbers is not good. Forget about the inflation concerns. I'm more worried about the ability of the consumer to keep our economic boat afloat. Real wages are dropping, which has been masked by the ability to withdraw equity from our homes and withdrawals from savings (negative -0.5% savings rate for all of last year). Then we have increased costs for housing, loans and energy, to name but a few, and the combination is going to kill the consumer. Already the sales picture at the lower priced stores (Wal-Mart, Family Dollar Store, etc.) shows that our lower income group is suffering. And while real wages slow, benefit costs are increasing. This will make it more difficult for companies to control costs to the bottom line, which will of course hurt earnings. But our economists continue to keep their backs to the woods and worry about the unseen inflation monster in front of them. In the meantime the recession monster is sneaking out of the woods for a surprise rear attack.
The Chicago PMI came in at 58.5, slightly lower than the 59.8 expected and a little lower than last month's 60.8. This is considered relatively strong and should be a positive indicator for next week's ISM report. Consumer Confidence got a little bounce to 106.3, higher than the 105.0 expected and higher than last month's 103.6 (revised from 103.8). This is the highest level since June 2002 (just before the big leg down in the market into the October 2002 bottom) which is probably not coincidental. The amount of complacency in the market today matches what it was back then and it's dangerous for the bulls.
Looking at the CC number, the present situation index rose to 128.4 in January from 120.7 in December, making it the highest level since August 2001. But the expectations index, which measures the near-term future, dropped slightly to 91.5 in January from 92.6 in December. The current jobs picture helped the present situation numbers but consumers are getting a little more nervous about the future.
Since the market instead had its eyes on the Fed, these reports were largely ignored. The market continued in its holding pattern until the FOMC rate announcement. No surprise, they raised their discount rate +0.25% to 4.50%, the highest it's been since May 2001. The FOMC said further rate hikes may be needed to keep inflation at bay. They also said "growth was solid, inflation was low and inflation expectations remained contained." However, they are apparently concerned about the increase in the capacity utilization rate and higher energy prices, both of which could add to inflationary pressures. In its statement, the committee removed language that suggested further rate hikes would be "measured," the word that had been in the prior 14 consecutive statements. The committee also said further increases "may be needed," a change in wording from December, when the committee said further increases would "likely" be needed. As usual doublespeak prevailed and I'm sure we'll have all the analysts out in force tonight to tell us what they really said. And my guess is we still won't know.
A few banks immediately followed and raised not only their bank-to-bank lending rates but also their prime rates to 7.5%. This rate increase makes it Greenspan's 40th rate hike over his tenure as Chairman and he now hands over to Ben Bernanke the reins to our economic ship. By the way, Greenspan had also dropped interest rates 46 times during his tenure and the average rate was 4.8% vs. today's 4.5%. What do you suppose would have happened had he just left rates alone all those years instead of chasing the market up and down with them? Just a thought.
There is of course lots of speculation about how gentle Ben will do as Chairman. "Ben Bernanke is going to truly have a difficult transition," said former Fed governor Lawrence Lindsey at a recent conference. Lindsey said that history shows that the last three Fed chairman had difficulty with financial markets--G. William Miller, the foreign exchange market, Paul Volcker, the bond market and Greenspan, the stock market. I expect Bernanke will be known as the one who had difficulty with the housing market. And in this case, unlike the stock market, printing vast quantities of money may not be as helpful to prevent a slide in prices. But printing-press Ben will give it a go I'm sure.
We've had a solid bounce since last week's low but it looks short term tired. It's always a challenge figuring out whether or not post-FOMC price action will be at all telling for the next day. We some times see follow through to what price did into the close and other times we see a complete reversal. GOOG's disappointing earnings set the futures back after hours, but we've seen that often reversed after the cash market opens the following morning. So let's see if the daily charts present any clues.
DOW chart, Daily
The bounce in the DOW from last week's low has taken it back above its 50-dma, a bullish development. But it stalled around the 62% retracement of the drop from the January high and is showing some short term negative divergences. I get a slightly different picture from the various major indices and while all look close to a top for this current bounce, it's not clear whether or not we're due a minor new high before we'll be ready for a deeper pullback at a minimum. Today's end-of-day price action, and the after-hours futures action, does not necessarily tell us anything about tomorrow. At the end of the day today price dropped back down to the bottom of a parallel down-channel as seen in this next chart.
DOW chart, 30-min
This 30-min chart shows the parallel down-channel that has formed since last Friday's high. It looks like a bull flag so far and suggests a bounce tomorrow pretty much out of the gate. If price continues down tomorrow then obviously this bullish pattern is not playing out but at this point I think the bears need to prove they're in control. From an EW perspective, the inside pattern can count complete at this afternoon's drop and again suggests we should see a rally tomorrow. However, the rally may only be to a minor new high for the leg up from last week's low. It could be a head fake rally that traps a lot of bulls so be careful about any new high if we get one. On the other hand, if price breaks down from this channel, look to play the short side of the market.
SPX chart, Daily
SPX bounced right up to the trend line along the highs from January 2004. It's pattern is slightly different from the DOW in that its high yesterday could have been it for the bounce from last week's low. The fact that this one looks more bearish to me suggests the DOW will break below its short term down-channel shown above. The difference between the two indices, and the unclear short term picture for both, suggests caution tomorrow morning until we see how the post-FOMC volatility shakes out. For now it would appear that we have resistance at the recent high of 1285 and support at the uptrend line and 50-dma near 1267, a fairly wide range to be sure. A break above 1285 suggests a minimum upside target of 1304, more likely around 1310, whereas a break below 1267 would suggest a drop to its 200-dma around 1220. For the moment be nimble.
Nasdaq chart, Daily
The chart of the COMP looks more bullish than the DOW or SPX but it could see more of a negative impact from GOOG's earnings. After showing negative divergences on its short term charts at the retests of the highs above 2310, it looks like an ominous triple top. But remember what happened to the SOX last week after facing the same dilemma on its daily chart--it gapped above and had a strong day. If this one can press higher, I still like the 2350 area for an ultimate target.
SOX index, Daily chart
After that strong gap above its triple top last week, the SOX has dropped back down and is only points away from closing its gap. Resistance turned support around 537 is what the tech players are hoping. It should be good for a bounce so watch that level tomorrow. Any bounce and then a drop back through 535 would be bearish. If that level holds, the SOX could be looking much higher around 573.
BKX banking index, Daily chart
A kiss and a slap is the way this one is setting up. The banking index jumped up to give its broken 50-dma a kiss goodbye and has since pulled back. This looks bearish. The negative divergence on MACD looks bearish. The negative MACD looks bearish. What looks bullish on this chart? Nothing. Well, that's not true. Daily stochastics looks bullish but stochastics can get flipped around in a heartbeat. Remember, these oscillators are rear view mirror analysis tools--they tell you where you've been and a trader's hope is that the momentum that they're showing will continue. Another red candle tomorrow would likely have stochastics tipping back over. But the banks look ready for at least a small bounce so we'll see if it develops into something more, especially if the broader market rallies.
U.S. Home Construction Index chart, DJUSHB, Daily
After breaking its steep downtrend from the January high, the home builders have been putting together a bounce. It looks like one leg of the bounce has completed, we're getting a small pullback and then we should get another leg up a little higher to complete the correction against the January decline. I have some Fibs lining up around 990-995 for a target for the bounce. If it plays out like I think it will, after the next bounce finishes we should see a strong leg down in this index.
In last Thursday's Wrap I discussed the housing market and home equity extraction. I had mentioned that U.S. homeowners pulled out about $600B last year, half of which was spent on non-housing goods and services. That's a lot of money injected into the economy and was essentially a big loan made taken on by the consumer to help keep our economy strong (dutiful and patriotic people that we are). I had also mentioned that that money equated to roughly half the GDP growth we've experienced over the past few years. We know refinancings are down and home equity loans have dropped as home owners hear more and more about the housing bubble and the potential for it to deflate. That makes them nervous about taking more money out of their house.
On Friday, after we heard the lower than expected GDP number of 1.1%, most economists quickly came out of the woodwork and declared the GDP number as bogus. GDP growth was even weaker when you strip out the contribution of inventory building, and final sales fell for the first time since the recession of 2001. But the economists felt the number was wrong and of course that was because they didn't see it coming and were wrong in their estimates. So instead of correcting their estimates, most came out and blasted the number as totally inaccurate. Even John Snow, our Treasury Secretary, who I'm sure has no political motives whatsoever (cough), came out in support of the economists and said the numbers will very likely be revised sharply higher next month. I wonder whose job is riding on the "correct" number coming out next month. Remember, these are the same economists who haven't been able to accurately predict the next recession even after we're 4 months into it.
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Some economists get it though. Christian Weller, senior economist for Center for American Progress said on Friday, "Today's figures show that in the fourth quarter of 2005, consumers simply ran out of steam." Bernard Baumohl, executive director of the Economic Outlook Group said, "When consumers are burdened with heavy debt loads, rising interest rates, higher energy costs, no personal savings and household income growth that falls below inflation, something had to give." Maybe the GDP number is too low and will be revised upward but it seems to me the outcome here was easy to see coming. We've heard for several years how important it is for the U.S. consumer to keep spending because they are the powerhouse behind the economy. The fact that so much of the spending has come first from stock market equity and then from housing equity, it was a matter of time before the money tree was going to be plucked clean.
On Monday though, to my great relief, Assistant Treasury Secretary Warshawsky came out and said the slowdown to 1.1% growth is only temporary and that the economy is on "firm footing". I live in Seattle now and after the record amounts of rain we've been getting I know there are quite a few people who felt they were on firm footing as it slid down the hill. And I'm not sure anyone asked Warshawsky to define temporary. In the greater scheme of life, a slowdown for 5 years could be considered temporary. Understand that the job of the analysts, economists and government officials is to keep the sheep quiet. We don't want any panic in the streets and we sure don't want investors to start selling and consumers to stop consuming. Listen to these people at your own peril. Due diligence and studying the facts, not to mention the charts, is an absolute must in order to survive the market.
If consumers are pulling back on borrowing and spending then it's likely we'll see a drop in GDP. I agree with most that it seems like an excessive drop so I have no doubt we'll see some upward revision next month. And if we don't then we'll probably see the market crater as general recognition hits the streets. But with Monday's numbers showing an increase in US consumer spending in December we can't blame all of the GDP slowdown on the consumer. What we can and should worry about is the fact that the savings rate for the year was -0.5%, the lowest rate since the -1.5% savings rate in 1933. We all know why Americans were pulling money out of savings in 1933--it was the heart of the Great Depression and people were digging into savings in order to survive, literally. What's our excuse now? This negative savings rate is on top of the most lucrative years in America. If people are not saving but instead borrowing more and digging into savings now, what will be available when (not if) we fall on harder times. The baby boomer generation is already wholly unprepared for retirement.
The negative savings rate is a reflection of huge complacency out there. Most people don't consider the period we're in to be risky. That makes it all the riskier. On Thursday I'll discuss a little bit about contrarian thinking and how extraordinarily difficult it is. Suffice to say, most people are happy at the moment and think the good times will continue for a long time, certainly through this year. This makes it likely that any economic contraction will spook most people and see them pull in spending big time. It will exacerbate any slowdown and make it much worse much faster. Our job is to not follow the pack of lemming off the edge of the cliff but instead prepare ourselves and be contrarians now. It's hard to do and very uncomfortable but it's important to our economic survival, and prosperity if we play it right.
Oil chart, March contract, Daily
Oil continues to probe for a top. As shown in the chart of the oil stocks below, they look like they're predicting higher oil prices. Either that or the euphoria of record profits is putting stars in the eyes of oil stock holders. But the oil chart is not quite agreeing with that. Or if we do see a new high in oil it will probably be a minor one and will probably have negative divergences associated with it. In either case it looks like oil is topping. I continue to think my EW count is correct which calls for a sharp move back down once the bounce is finished. The leg down should take us below $55 so a break of the long term uptrend. That would be a strong signal that our economy (on a global scale) is weakening.
Oil Index chart, Daily
The rally in the oil stocks has clearly gone on longer than I had expected. After getting up through a Fib target of 575 and the top of a parallel up-channel near 580, it looks like this could be headed to a Fib target of 613. As shown in a closer view of the rally leg, this is also at the top of its current up-channel and makes a good target to tighten up stops on longs, and look for some shorting candidates in this index. The new highs in this index could be predicting new highs coming in the price in oil but more likely in my opinion is that it's reflecting the bullishness as a result of their record high earnings. But the negative divergence that could be developing on the daily chart here could be telling us the momentum is slowing.
Oil Index chart, 60-min
From the low in December this short term chart shows price reaching up towards the top of a parallel up-channel for the rally. This channel, and the wave pattern, tells me we should get a little higher before the rally tops out, or at least gives us a larger pullback. So watch for 610-615 to be resistance.
Transportation Index chart, Daily
Oil is rallying and the DOW is dropping. Sounds like a perfect recipe for the Trannies to rally (huh?). Against all odds, this index has rallied to new all-time highs. However, the current leg up from the January low looks like an ending pattern and it fits the larger wave pattern to the upside showing that the rally is coming to an end. As shown in the close-up view of the last leg up, this one is running out of momentum.
Transportation Index chart, 60-min
The leg up from mid-January has formed an ascending wedge. In the larger wave pattern this leg up appears to be a 5th wave and the ascending wedge is called an ending diagonal. This is very common for the final 5th wave of a strong move--it shows the move is running out of momentum and the negative divergence showing up on MACD supports this interpretation. Ideally we'll see a thrust higher above the top of this pattern and then a collapse back inside. That would be a sell signal and confirmation of a top would be a break of the uptrend line currently near 4350. This is one of the most bearish setups I see in the market right now so if you're long transport stocks, tighten up those stops and look for some shorting candidates in this index.
U.S. Dollar chart, Daily
The US dollar got a good bounce off its bottom last week and got back above its 200-dma. It has now pulled back to it so we'll see if it acts as support now. Note the bullish divergence at the last low as well. The dollar should continue its rally from here and I would expect next resistance at its broken uptrend line and 50-dma, both near $90.
Gold chart, February contract, Daily
Like trying to pick a top in the oil stocks, gold keeps blowing me a raspberry every time I call a top. But like several of the indices that I've reviewed, this current leg up appears to running low on momentum, and suggests the move up is getting tired. The negative divergence on the daily MACD continues and if gold rolls over here it will also leave a negative divergence on stochastics. I'll say it again, traders who are long gold should bring their stops up a little tighter and if you'd like to play the short side, this should be close to a high but I see the potential for gold to run up to about $580. This is based on a measured move out of a sideways triangle that just finished playing out the past week. By the way, the little sideways triangle also points to the current move higher as the last one (4th wave triangle points to the final 5th wave up here).
Results of today's economic reports and the rest of the week's reports include the following:
Tomorrow we'll get Construction Spending and ISM at 10:00 (so no significant pre-market reports), Crude Inventories at 10:30 and the Auto and Truck Sales at 12:00. It's possible the ISM number could be a market mover if it's significantly different than the expected 55.5 which is essentially the same as December's.
The open might be a little volatile due to post-FOMC volatility. Tonight's word- and number-crunching analysts will have voiced their opinions and if some kind of consensus is reached, we could see the market move based on that. In addition to continued reactions to the FOMC wording changes, GOOG's (GOOG 433.05 +5.84) earning's might sway the market. GOOG announced Q4 profit rose 82% on growth in its online advertising business, saying they earned net income of $372M, or $1.22 a share, up from $204.1M, or 71 cents, a year earlier. Sales rose 86% to $1.92B, saying they took market share from their rivals Yahoo, Microsoft and other search engines). Excluding payments GOOG made to partners who send it internet traffic, net revenue rose to $1.29B. Expectations were for earnings to rise to $1.76 a share on net revenue of $1.29B. So the miss was more on the earnings per share rather than the net income. I haven't had a chance to study the number to see where the added costs came from that affected the earnings but it appears the expectations were so high for GOOG that it was clearly set up for a sell the news.
After GOOG announced their numbers the stock was taken out and publicly stoned, hanged, and then shot. They did it all in plain sight and didn't even bother to take it behind the wood shed. After-hours price dropped to a low of $350 before bouncing into its 6:00 PM closing price of $379.01. Today's high was $439.60 so it got a $90 (-20%) haircut before bouncing. As Marc Eckelberry observed on the Futures Monitor, GOOG may be headed to gap closure just above $300. And Mark Davis noted the island reversal on its daily chart (small island of candles from January 6th through the 17th). This is a highly reliable reversal signal. The weekly chart shows an evening star reversal pattern which is a small doji candlestick at the top followed by a big red candle. Both of these patterns tell us a major high of some kind is probably in for GOOG. And if GOOG is our measure of speculation in the market (a measure of how bullish things are), then we're probably at a major turning point in the market.
But before abandoning GOOG, one thing to keep an eye on tomorrow is the $374 level. This is where it has two equal legs down from its all-time high. If this pullback will lead to another bounce, even if not to a new high, this level would make for a natural support level. Keep an eye on this stock tomorrow.
As for the rest of the market, let the early morning volatility settle a bit before trying to discern a direction. Prices are at or near support levels that portent a rally out of the gate tomorrow. We've seem time and again negative futures in after hours as a result of earnings that get reversed at the cash open. If I were to pick a direction for tomorrow, I'm thinking long. But if we see a drop tomorrow and find resistance at today's close, things could get a lot uglier. SPX 1250 and DOW 10600 could be next. Stay nimble and don't get married to a position. If you're long the market, this is a risky time for you. Protect your position. If you like playing the short side, it's still a tough game as the increased volatility (normal in a topping process) makes it incredibly difficult to hang onto a trade. Good luck and I'll see you on the Futures Monitor.