Volatility everywhere, buy programs, sell programs, competing economic analysis, nerve gas and fading earnings gave investors another case of indigestion. The markets reacted to these sound bites as though as though hearing them second hand and not sure of their importance. Competing buy/sell programs provided the majority of the week's activity and with the exception of the Dow the indexes close very close to flat for the week. Blue chips were up, techs flat and Russell hit a new two week low. The NYSE composite swapped sides with resistance and support twice on either side. Volatility, although lethargic, was the name of the game with the S&P finishing only +3 points from where it started the week.
Dow Chart - 180 min
Nasdaq Chart - 60 min
Chart - 60 min
A stronger move came from the Treasury Budget released at 2:PM. This report showed a budget surplus in January of $21 billion but that was not the key. The portion that provided some market lift was the details showing rising individual income and rising taxes despite the lower tax rates. This was seen as a positive for the economy along with a jump in corporate tax payments of a whopping +27% through January. Revenues from personal income taxes were up +11% for the first four months of the 2006 fiscal year. The fiscal year for budget accounting runs from Oct through September. Friday's numbers represented the first four months of the 2006 fiscal year. The Treasury Budget was released at 2:PM and a strong buy program kicked off several minutes later adding +2000 issues to the A/D line over the next hour. While the market gains were attributed to the budget release I believe it was simply end of week short covering sparked by the buy program rather than some misplaced euphoria over a dull report on budget accounting.
A continued drop in energy prices has not provided a bounce in equities and has actually removed some support with implosions in numerous energy stocks. Sunoco was the poster child for the end of momentum in energy stocks. SUN has fallen from $96.50 on Feb 1st to close at $72.50 on Friday. This -24 points, -25% drop is purely a result of sector rotation out of the energy group. Those momentum leaders over the last few months have switched directions and are now the leaders on the loser board. I have been predicting this pre-March dip in oil for weeks but the magnitude of the selling in some individual issues has been very surprising. Valero (VLO) is another example of traders bailing with their profits with a drop from $64 on Jan-31st to $50 on Friday. That $50 level represents a strong buy level for me and I did act on it.
Sunoco Chart - Daily
Crude Oil Chart - 90 min
Oil fell to close at $62 and -$7 off its Feb highs and Natural Gas fell to a new 52-week low at $7.33. Oil at Friday's $61.20 lows was under the 200-day average at $61.69 and only the third time this year that oil has touched that 200-day level. Despite this intraday break I still believe oil is going lower. $58-$60 is strong support and I believe this correction will eventually see those levels. We are close enough to that expected bottom I did see some bargain hunting in some energy stocks just before the close.
The northeast is facing their first real winter storm of the season this weekend but there is no shortage of gas or heating oil. The mild winter has allowed natural gas supplies to grow to near record levels and +36% over the five-year average for this time of year. Heating oil supplies are also well stocked and refiners are already shifting to gasoline for the summer season. The storm should not cause any material jump in energy prices unless the cold is so bad and lengthy that the water around Manhattan freezes over and commuters walk across the ice to work. In short, it is not going to happen this year!
Oil service companies and drillers were not completely immune to the selling but stocks like HAL, SLB, DO and RIG finished positive for the day. They are not tied dollar to dollar to oil prices with service and drilling contracts now going for record prices with commitments for several years into the future. The Oil Service Index (OSX.x) has only declined just over -9% in February compared to monster drops in a few individual stocks.
Energy commodities were not the only futures taken behind the woodshed for a beating. Gold has fallen -$26 for the week to close at $549.50 on Friday. There are many reasons being given for the drop including the suggestion that a recession is less likely today than last week. I think whoever floated that excuse is delusional but they are welcome to their opinion. Personally I think the Iran factor has cooled and oil prices have fallen. That takes the fear factor out of gold as a safe haven and cuts down on the petrodollars available for investment into gold as an oil hedge. The Middle East producers export about 30 mbpd. At an average drop of $7 a bbl that is a loss in revenue of $210 million per day or $1.47 billion per week. That excess cash buys a lot of gold even if only a minor portion is allocated to that hedge. Like the dip in oil prices the dip in gold should only be temporary. Iran will come back to the headlines and OPEC will prevent oil prices from falling much further.
Another commodity on the ropes is copper. Friday's -5% intraday drop was the largest single day drop in copper futures in several years. The drop was blamed on downgrades to the copper stocks rather than a drop in demand unless of course you listen to Prudential. Phelps Dodge was downgraded by Prudential on Friday but it was already in free fall before that late hit. Prudential should get a 15-yard penalty for that personal foul. Prudential cut its investment rating on the copper industry in general to "Neutral" from "Favorable" on what they called "weaker-than-expected demand" in the U.S., South Korea, Taiwan and Japan. PD closed at $142 and well off the high for the week at $166. (-$24) With Market Vane still showing a 90% bullish rating for copper it was only natural that copper stocks were hammered by the current commodity correction. Pigs get fat, hogs get slaughtered being the current theme.
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Prudential's downgrade was not unanimous in the analyst community. On Thursday, Goldman Sachs analyst J. Alberto Arias said he sees more evidence of an extended copper cycle ahead -- not less. On Thursday he wrote, "Over the past two weeks, three major copper producers have cut their 2006 production guidance by 145,000 tonnes, which supports our view of a market deficit this year." The analyst forecast a "bull-case scenario" for copper prices at $2.12 per pound, with the price floor at $1.60. He noted that Phelps Dodge Corp. and Freeport McMoRan Copper & Gold Inc., in particular, are poised to benefit from copper prices anywhere in that range. Freeport McMoran (FCX) was hammered for a -$10 loss after the government of Indonesia said they wanted to raise their cut in the current profit sharing arrangement with FCX.
I should comment here about stock ownership. What commodities have been the momentum favorites over the last year? Oil, gold and copper. I listed the two biggest losers above, SUN and PD both losing -$24 each since February began. My point? These are two of the highest institutionally owned stocks in the market. PD is 95% institutionally owned and SUN is 79% owned by institutions. SUN traded more than three times its average volume on Friday and PD more than twice its average. Profits are being taken by funds and sell stops are being hit daily. It does not mean there is a bear market forming in commodities, just that profits are being taken in prior momentum leaders. The question for us today is where are they putting that money?
It appears much of it is going into international funds, overseas Ishares and Holders. TrimTabs reported that $3.9 billion came into the market last week but U.S. funds only received $1.3 billion of that total. I think we can assume that money received from selling those momentum stocks above may be allocated in the same ratios for current investments. With a battle brewing in the U.S. between the Fed rate hikes and a possible recession U.S. equities may not be seen as a safe haven based on current money flows. For money going into U.S. stocks it appears the favorite sectors are healthcare, defense, a few biotechs, oil drillers and oil service stocks and selected transports. Railroads, BNI, CNI, UNP, CSX are seeing inflows as well as a couple airlines AMR, CAL and UPS. You would think with oil imploding it would have greased the transports for a strong gain. However, transports have already run their race as we saw in Q4 and are fighting for traction today. Financials have stopped falling but have yet to rally. I believe the uncertainty about the Fed is holding them back.
Hopefully the Humphrey Hawkins testimony next week by Ben Bernanke will give us some insight into the Fed's future. This will be his first report to lawmakers on Tuesday and Wednesday and they are likely to take it easy on him since they don't have a lot of Bernanke history to pick apart. This will be his opportunity to layout his plan and tell them how he expects to run the Fed. He no longer has to answer to Greenspan and helicopter Ben is in charge of his own fate. With rate expectations currently at 5% and growing and GDP expectations for 2006 at 3% and shrinking there are some dangers ahead. The markets should pause ahead of Tuesday's testimony until some of those questions are answered.
Google took it on the chin this week that ended with a -$60 drop from its $432 pre-earnings close. Google seems to have found support in the $360 range but Barron's is going to do a hatchet job on them this weekend. The Barron's premise is that Google is overvalued even at the current level. Since GOOG is the REAL poster child for a momentum stock there may still be some sellers lurking just overhead. There is a gap still waiting to be filled at $303 but that is a long way from $360. Expect volatility in GOOG on Monday.
Google Chart - Daily
Pfizer (PFE) punished investors who capitalized on the strong early week rebound to near $27 by warning about future profits. 57 million shares traded on Friday knocking the stock back to $25.50 intraday. Pfizer said patent expirations would hurt earnings and revenue growth would be flat. Pfizer said the company was moving from the old Pfizer to a new Pfizer with old patents expiring but a new wave of new medicines approaching. Zacks Investment Research took exception to the news claiming the $4 billion cut in expenses last year was supposed to improve results in 2006 and beyond but those improvements seem to have disappeared. With the recent rebound to resistance at $26.50 investors should be cautioned about future gains until more guidance is made available.
Quality Systems (QSII) found out it is not nice to miss earnings targets with a drop from $92 to $70 after missing estimates by a dime. Piper Jaffray upgraded QSII after correctly sifting through the earnings and realizing that $4 million in net income had to be deferred to the next quarter cutting their recognizable income nearly in half to only $4.6 million. The nearly -50% cut in net income was responsible for the dime miss and had they been able to recognize the income as planned they would have beaten street estimates. The company did not say why the income was deferred but they did say the NextGen licenses were sold and paid in full during the quarter. On the surface it looks like a buying opportunity but we still need clarification as to why the income was deferred.
The market was bipolar for the week with a downdraft on Tuesday, rally on Wednesday, failed rally on Thursday and an end of day buy program on Friday. It is hard to determine a market direction when the last three market moves in alternating directions were a direct result of large buy/sell programs. Market direction simply depends on which program executed last. The Dow was the strongest index for the week and tested resistance at 10950 twice with no success. This level has resisted all but one breakout since November 23rd. We did see one spike out of the range the second week of January all the way to 11045 but the Dow could not hold its gains and it slipped beneath the 10950 level once again. This remains the level to be watched as February progresses.
The Nasdaq is slowly building a bearish formation with 2240 as support and a series of lower highs dating back to January 12th. The programs last week produced a spike to 2285 but it was short lived with a Friday close at 2262. The negative setup on the Nasdaq is nearly identical to the setup on the SPX. Lower lows and lower highs since mid-January. The SPX performed almost perfectly for those following the SPX as our long/short indicator. On Tuesday with the SPX at 1255 I told everyone that the market was oversold and a trading bounce was likely. I suggested shorting weakness on any oversold bounce given the negative fundamentals. The SPX rallied out of the 1253 intraday low on Wednesday to 1274.50 on Thursday morning before weakness appeared. You should note that is appeared right at 1275 where we expected resistance to appear. Once the roll over began our 1270 short indicator was crossed almost immediately giving everyone a perfect setup for an exit from their Wednesday long and right back into a short at 1270. The SPX crashed right back to 1254 at Friday's open before the afternoon buy program returned it right back to 1270 once again. You could not script this better for traders. If you followed my suggestions you should have made a couple very good trades.
NYSE Composite Chart - 60 min
Next week the same rules apply. We need to remain short under SPX 1270 and cautiously long over 1275. That recommendation has not changed in several weeks. Until this trading range changes there is no need to do anything different. I know it sounds simplistic but it takes the emotion out of the decision and we trade in the direction of the trend. Next week the economic calendar has some more meat in it with the PPI, Industrial Production and a couple of Fed surveys. The semi book-to-bill comes out Thursday night and it will be interesting to see if bookings can go positive for the first time since Sept-2004. The last reading was .96 meaning only $96 dollars in orders were received for every $100 shipped. The SOX needs some good news to provide support for the Nasdaq. It has been holding above 530 but is starting to look heavy.
If I had to
take one trade next week it would be Valero. The monster drop on
Friday took it back to strong support at $50 and there is a much greater chance
of a rebound than a continued drop. But, oil prices could continue to decline
with strong support at $58 and -$4 below Friday's close. Whatever you decide to
trade next week just don't get married to your position. The markets are not
giving us any directional help and volatility is the only factor we can count
on. Until a trend appears I
would be continue to be cautious especially on longs