Traders were pleasantly surprised today when a combination of factors converged to produce a strong market bounce. While this was not the kind of Valentines present they expected I doubt anyone turned it down. The Dow rallied back over 11000 to test highs for the year with the intraday high coming within .08 of equaling the January high of 11047.76. It was strictly a Dow day with the Nasdaq still closer to a six week low than a new high. The S&P stalled right at the 1275 resistance we have been watching for weeks and well below the 1295 high for the year. Big caps are favorite hiding places for big money when market direction is questionable and it appears they were the recipients of those funds today.
Dow Chart - Daily
Nasdaq Chart - 120 min
SPX Chart - 120 min
The morning started off positive after a very strong retail sales report for January soared +2.3% and more than twice the consensus estimate of only +1.0%. Year over year sales surged to +8.8% overall and +9.9% if you exclude autos. This sudden burst of consumer spending caught everyone off guard. January strength came from Furniture and Home Furnishings at +3.7%, Building Materials +3.4%, Clothing +4.2% and Food Service +3.2%. The biggest gain came from Gasoline Stations, which rose +5.5% on higher gasoline prices, +22.7% year over year. The strong headline number was the biggest gain since May-2004. The strong numbers were also the result of the warmest January on record in many states. Shoppers were free to wander with 50-degree days and very little frozen precipitation. That is in sharp contrast to February with the northeaster shutting down much of the east coast for several days. This should put the skids on the February sales numbers but that fact was ignored today.
Despite the good retail news the markets struggled to remain in positive territory for the first hour of trading. Suddenly at 10:30, just like we have seen twice before over the last week a strong buy program was triggered, which forced shorts to cover. Shortly after the start of the buy program the price of oil began to dive. Those still clinging to their crude positions saw a break of $60 looming and elected to bail. The Transports caught fire as oil prices imploded and the index rallied to gain +109.45 and close at a new historic high of 4408. Oil eventually broke the $60 level to close at $59.60 but continued lower to $59.32 when the evening session began.
While the drop in oil may have been a contributing factor to the transport rally it was really neutral for the broader indexes. According to several respected analysts and technicians including Art Cashin it was simply short covering ahead of the Bernanke testimony on Wednesday and was stimulated by the morning buy program. The markets have had a negative bias for the last few days and three times in the last six days we have seen sudden buy programs squeeze those short positions.
The talking heads were irrationally exuberant about the Dow's return to 11047 but tended to overlook the fact that the Nasdaq, NDX, S&P, Russell and NYSE Composite were still showing a negative bias. Bottom line, cash is flowing into the big caps as a safe haven in times of market instability. Economic reports have taken a sharp turn higher indicating a growth surge underway in the current quarter but news like we saw from KB Homes today suggests there is still trouble under the hood. Bernanke's testimony tomorrow is expected to take a hawkish tone and investors were leery ahead of the event.
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KB Homes said today that it might have to revise its revenue forecast for the year due to slowing sales and a higher rate of cancellations. In an SEC filing the company said business had slowed significantly over the last two months. Rising interest rates, now up to 7% in some areas and the constant talk about a bursting housing bubble have prompted many buyers to reconsider their plans. We heard the same thing from Toll Brothers last week. Toll builds homes for the high end of the market and the higher priced buyers were the first to close their wallets. KB Homes build homes that are more affordable with many homes in the entry-level range for first time buyers. This weakening across the full range of buyers is a strike against the case for a stronger economy in Q1.
Some analysts feel this weakness will be made apparent when Bernanke testifies on Wednesday and big caps are where you want to be if the economy is slowing. However, there are just as many analysts raising their estimates for Q1 GDP with some estimates now reaching +5.0%. These competing views on the health of the economy are complicating not only the search for market direction but also the outlook for interest rates. Fed funds futures are pricing in a 5% rate by June but fully 38% of analysts polled expect at least three more increases. Bernanke's testimony on Wednesday will be one of the most watched events in years. Bernanke will be expected to describe his economic outlook, methodology and what the financial community can expect in the near future. Because his testimony is expected to be somewhat hawkish it is possible we could get a relief bounce if he comes off as bullish in any form. That potential was probably what prompted the short covering to be as strong as it was on Tuesday. Market neutral was probably the place to be heading into Wednesday and meant closing shorts when the morning buy program appeared.
Helping provide direction for the energy sector was a very surprising warning by Transocean Offshore (RIG). RIG said operating and maintenance costs would exceed year ago levels by $30 to $70 million in Q1 and by $70 to $90 million in Q2. RIG said higher shipyard and reactivation expenses in addition to higher operating costs were the reasons. Rigs are being pressured for constant uptime and that means maintenance issues are being postponed until the last minute and sometimes requiring more serious repairs. Harsher conditions, deeper water and damage from the hurricanes forced many rigs to be returned to a shipyard for extensive upgrades and repairs. Those rigs with the most capabilities and highest day rates are also the ones with the most maintenance. This pressured earnings for RIG and they missed estimates by a penny. RIG lost -$6.49 for the day and pulled all the other drillers and service companies lower. Examples include NBR -2.35, SLB -3.03, NOV -2.57, ATW -2.56, HAL -1.74, BHI -2.07.
Crude Oil Chart - Daily
The RIG warning was even more detrimental to the sector with oil prices falling through the $60 level. The double punch produced broader sector weakness as prices neared support at $58. As we near $58 the potential for bargain hunting grows with each nickel lost. The $58 level will be the real test for oil as that was the support lows in Nov/Dec for the current contract. This is also where OPEC should start making noises about production cuts in an effort to support the price. I am a buyer of energy stocks this week with an expectation of support appearing at that $58 level. Iran should start moving back into the spotlight next week as their meeting with Russia over enriching uranium on Russian soil begins. This is the last hope for the Iran problem to go away. Iran announced today that they had begun attempts to enrich uranium at a faster rate now that the IAEA cameras and controls had been removed. Russia has offered to produce reactor fuel for them on Russian soil but up until now Iran has declined the offer. Russia also offered to sell them a lifetime supply of fuel for their reactor for the paltry sum of $35 million, only a fraction of what it is worth. Iran's rejection of these offers seems to prove to the world that their goals are not peaceful as they claim. Otherwise why not take the offers and escape world condemnation. If next weeks discussions with Russia end quickly without any agreement then oil prices are sure to rise. The confrontation with the UN is expected to dominate the news once the February calendar expires.
With option expiration only 3 days away Wednesday's oil and gas inventories are sure to produce some further movement in the sector. Inventories are expected to show another build and traders holding call options will be dumping them after the announcement. Last weekend's blizzard should not have any impact on the numbers reported tomorrow. Natural gas inventories will be reported on Thursday and despite the expected draw from the blizzard the price of gas is not expected to rise significantly. With supplies more than 25% over the five year average it is only a matter of days before we see prices under $7.
The falling oil prices sent transports soaring to a new historic high with the standouts being railroads but airlines were also flying high. Continental and AMR both moved to new 52-week highs but their gains were nothing compared to Burlington Northern (BNI) +2.77 and Union Pacific (UNP) +2.66. UPS added +0.89 but FDX was the package-shipping star at +2.58. UHAL added +4.20.
Google did not join the rally and continued its downward plunge with a close at $343.33. Copper stocks had been setting new lows but today's rally saw buyers move back into the oversold sector. Phelps Dodge gained +4.96, Rio Tinto +5.45 and Southern Copper +3.06. Titanium Metals reversed a weeklong slide of -15 points with a +3.46 rebound. Home Depot and Lowes also rebounded out of their multi-week decline with decent gains. Banks and financials also found buyers with CME adding +8.77, Lehman +4.12 and Blackrock +3.97 to lead the sector.
Apple was the only tech stock to stand out from the crowd with a +2.93 gain but after the -$22.80 decline from the January highs it was simply an oversold bounce and not a revival. The Nasdaq is still showing a negative bias with the Semi book-to-bill due out on Thursday. The major semi stocks showed no life ahead of the report and failed to take part in today's rally with minimal gains of only a few cents each. AMD was the only exception with a gain of +1.26. Without the semiconductors the Nasdaq remains listless. The rebound today may have added +22 points but the close was still under Friday's high of 2266, which was also the high for today. This rebound came after a new six-week low was set on Monday at 2232. Despite the rebound the Nasdaq is still maintaining a negative bias and there appears to be no excitement on the horizon to break the trend. The NDX rebounded from its six week low around 1637 to add +16 points but that was still another lower high in the series that began back on January 11th. A break of support at the 1637 level will be a new three-month low and target 1550.
NYSE Composite Chart - 120 min
NDX Chart - Daily
The Russell 2000 also rebounded from Monday's three-week low of 708 adding +9 but like the Nasdaq it is still in a short term down trend. After the morning spike the SPX battled resistance at 1275 all afternoon and closed right at that level. This was only slightly higher than the 1274 high hit last Thursday. The SPX is also locked in a downtrend since the January high at 1295 with strong resistance just overhead. The NYSE Composite has been trading mostly in a range from 7925 to 8050 and today was no exception other than a stall at 8030 and almost exactly where it stalled on the last two attempts.
Make no mistake. Despite the Dow's return to its highs the rest of the indexes are still showing a negative bias. The Dow may have retested its highs on the strength of the blue chip buy programs but the rest of the market is not following the generals. Until there is confirmation from the troops it is just big money flowing into the safety of blue chips. Fund managers are raising cash with cash levels rising from 3.5% to 4.1% over the past two weeks. Bonds are being sold with yields rising ahead of the Bernanke testimony. Some of that "cautious money" is making its way into the blue chips on the outside chance the +1.1% GDP in Q4 was a hurricane fluke and the Q1 GDP is going to show a strong rebound in progress.
My recommendation for the rest of the week will remain the same. Be cautiously long over 1275 and short under 1270 until conditions change. Those conditions could change based on what Bernanke says and how he says it. I am sure the interrogation squad will at least be happy that they can understand the answers to any question posed. The days of asking an aide what Greenspan really meant have passed. Bernanke does use a clearer form of English with some sarcasm that has gotten him into trouble in the past. I expect him to be very precise tomorrow in his first appearance as the new Fed head. How the markets react will be anybody's guess. With the Dow adding +136 points to end at its resistance highs we could see some profit taking ahead of the testimony. After that it is up to helicopter Ben to set the direction.