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Market Wrap

Google Surprises

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The Nasdaq may be regretting the addition of Google to the Nasdaq 100. Several times over the few weeks since Google joined the index the overall market has suffered greatly from Google problems. On Tuesday Google's CFO said growth would slow and advertising growth would depend on overall market growth instead of improvements in its ad business. He said growth was slowing and now largely organic since paid search monetization gains had largely been realized. In other words everybody currently spending money on search advertising has refined their programs and bidding for higher value locations had peaked. Once everyone is doing the same thing Google's potential for new money flow has slowed. Finding a replacement source of revenue that provides the same 90% grow margin as paid search is going to be tough. The CFO said Google is suffering from the rule of large numbers. The bigger you are the harder it is to grow at the prior rates. Cisco and Dell are very familiar with this problem. This admission by the CFO caused GOOG to drop -$50 early in the day to touch support at $340. Buyers rushed in but the rebound was weak. Google finished the day at $361 losing more than $10 billion in market cap at its lows.

Dow Chart - Daily

Nasdaq Chart - 120 min

Google was not the only piece of negative news with a flurry of economics also clouding picture. Consumer Confidence for February dropped to 101.7 from last months 106.3 and well below consensus estimates at 104.7. The decline was entirely in the expectations component falling from 92.1 to 83.3 or - 8.8 points. The present conditions component rose slightly from 128.8 to 129.3 and the highest level since August 2001. Analysts were unsure why concerns about rising interest rates, slowing housing markets and high gasoline prices should accelerate so suddenly. These concerns have been around for months but they suddenly took on greater importance in the February outlook. I warned about a month ago that the arrival of credit card bills with holiday charges would pressure consumers and it appears that came to pass. I am sure utility bills from the last four weeks of cold weather did not help either.

Adding to the market gloom was the Chicago Purchasing Managers' Index (PMI) and its sharp drop to 54.9 from 58.5. This also confounded analysts who expected a flat report or even a small gain to 60.0. This has even more dire consequences to the market since this is the fourth consecutive month of declines in the index. New Orders fell from 63.7 to 54.9 but order backlog rose from 48.3 to 50.6. Inventories also rose from 53.9 to 56.0 and supplier deliveries jumped from 57.8 to 59.2 while employment rose to 54.9 from 50.2. The drop in the headline number was aided by a drop in production from 60.6 to 56.0 and prices paid from 75.3 to 71.6. In brief, orders and production fell suggesting that the economy is losing steam. This report also suggests there is downside risk to the ISM report on Wednesday.

The Richmond Fed Manufacturing Survey rose slightly to zero from a -4 reading in January. After two months in negative territory the rise to zero in the headline number may have been an improvement but it was less than exciting for the markets. Internals were more positive with shipments rising from -7 to +2 and new orders jumped from -2 to +6. However, order backlogs sank even further to -13 from -10. The six-month outlook rose to 71 from 66 suggesting manufacturers are retaining their optimism.

Existing home sales fell -2.8% in January to 6.56 million annualized units. This was the 5th consecutive monthly decline. Existing home sales fell to their slowest rate in nearly two years. Inventory on hand rose to a 5.3-month supply and prices are weakening. Higher interest rates and the constant talk about a bursting housing bubble are to blame. Homeowners are finding it harder to bail out of their currently over financed properties and escape with any equity to buy another house. Homeowners have used their home equity as their personal ATM to raise cash for everything from cars, boats, college, medical bills, vacations, etc, while counting on rising home values to rescue them from the debt load. With housing prices sliding many are underwater and can no longer play the housing game and must now live in their debt trap homes until the market improves again. The inventory of single-family homes for sale is up +34% from just a year ago. This is the highest level since 1998. Condo inventories are up +50% over Feb-2005 levels. Creative financing vehicles are also drying up as prices slip and rates climb. This prevents many speculators from participating in the market and makes houses less affordable for homebuyers on a tight budget.

One economic report showing strong gains was the NY-NAPM, which rose sharply. The headline number for the report, the Business Conditions Index (BCI), set a new record high at 369.4, up from 356.7 in January. The six-month outlook rose a whopping +23 points to 73.1 from 50.0. Current conditions surged to 75.4 from 54.9. Clearly conditions in New York City are very strong and mild winter weather has allowed businesses to prosper.


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On a broader scale the GDP for Q4 was revised upward from 1.1% to 1.6% but that was less than the whisper number on the street. It was in line with consensus estimates but many analysts were hoping for something over +2.0%. Changes in internal components combined to restrain a sharp increase in the headline number. Government spending and investment in software and equipment provided an upward bias while a much larger than expected net export number provided some serious drag. Despite the very weak Q4 number we are still seeing some very strong estimates for Q1. According to some analysts trying to capitalize on their 15 second sound bite of fame we could see a Q1-GDP of as much as +6%. While this would be good for business it would be extremely bearish for Fed rates. The more realistic estimates are back in the +4.5% to +5.0% range and something more in the range the Fed could tolerate. The PCE core deflator, the Fed's preferred indicator for inflation, rose to +2.1% and right on the edge of trouble. The Fed wants that number to stay at 2.0% or lower and over that level they will continue raising rates. Currently a 5% Fed rate at the end of May is nearly guaranteed with a 5.25% rate at the end of June only slightly less likely.

Economics on Wednesday will be closely watched with the ISM leading the list. Consensus estimates are for a rise to 55.6 from 54.8 but there are plenty of analysts privately expecting a drop instead. Q1 has been very strong economically if you believe the chatter but there are worries that the Q1 bounce is already slowing.

Fear of a drop in the ISM was probably more of a market negative on Tuesday than the Google news. After seeing the S&P hit a new 4.5-year high at 1297.57 on Monday the market was ripe for a sell off on any negative news. When markets are struggling at their highs they typically seize on any news event as a reason to take profits. Tuesday gave them several with the Google implosion, Consumer Confidence, home sales, PMI and fear of tomorrows ISM.

Oil prices struggled to hold over $60 as Iran came back into focus only a day after they supposedly agreed to let Russia process uranium for them on Russian soil. Comments made public suggested they had no plans to stop their own efforts even after the Russian deal. Even worse were comments from Venezuela and Hugo Chavez that he wanted to stop oil exports to America. This is not new and I have reported on it several times recently but it keeps cropping in his conversation. He also wants to develop stronger ties with China, Cuba, Iran and North Korea. He is rapidly trying to form a coalition against the U.S. with the intention of causing us pain from higher oil prices. He is becoming so radical that he fear the U.S. will invade Venezuela and is taking precautions against it. On Tuesday the Rebel Colombian Revolution Forces (FARC) said it would provide "unconditional support" to Chavez if the U.S. invaded Venezuela. For a country leader facing a tough election in December he could be even more dangerous than normal. Standing up to the U.S. is seen as a plus in Venezuela and I would not doubt some future action by Chavez to aggravate America. Halting oil exports even for a brief time could be seen as a punishment for America and the resulting high oil prices would offset any temporary monetary losses. Something as simple as a five day halt could get him plenty of positive press in Venezuela and a rise in stature among those countries he is trying to add to his circle of friends. Heck, I would not doubt it if they are spurring him on since they have no risk in the event.

Crude Oil Chart - Daily

All of these comments combined to push oil prices back to near $62 after dipping to $60.37 intraday. There seems to be no shortage of oil volatility and most of the stocks in the sector ended the day in negative territory despite the rebound in oil prices. It is entirely possible some of those losses were due to end of month profit taking by funds. Hardest hit was the refining sector with GI -3.62, SUN -2.29 and VLO -1.66. Refiners were hit after Friedman Billings and Bank of America cut their estimates on the sector. Gas prices are expected to rise due to the conversion from MTBE to ethanol by May 6th. MTBE is being eliminated after it showed up as a contaminant in ground water and in the food chain. Currently there is not enough ethanol to replace the MTBE and refiners are scrambling to buy future deliveries. This is expected to lower margins for the refineries. Personally I think it will just push gas prices higher and those refiners delivering product will profit. Daily gasoline production is expected to decrease by -300K to -500K bbls due to the change. Diesel is expected to drop -500K bbls on the corresponding move to lower emissions. Natural gas finally broke support at $7.00 but it will be too late to prevent some monster February heating bills from further depressing consumer sentiment. The $6.59 low was the lowest price seen since March-2005 bringing prices full circle over the last year.

Despite the Tuesday drop the Dow closed the month with the best Jan/Feb performance in eight years. It was the only index able to make that claim. The Dow started the year at 10714 and closed February at 10994 for a gain of +280 points. Considering how many weeks we have seen a swing of nearly that amount it may have been just timing that produced the eight year high. The Dow closed at nearly a three month low on Dec-30th after a strong +803 rally out of the October bottom. After three months of consolidating those gains and trading in a tight range just under 11000 last weeks spike to 11159 looked like the beginning of a breakout and a new move higher. Unfortunately all we got was two weeks of higher volatility at 11100 followed by Tuesday's dip to erase those gains.

The Nasdaq had been the weak sister but Monday's surprise jump had traders expecting the best after two months of a downtrend. Monday's spike to 2313 was exactly the resistance high the Nasdaq was unable to break for five days in early February. Tuesday's drop put it right back into congestion seen for most of the month. I believe Google's problems may not be over. There is an analyst meeting later this week and I am sure they will try to put lipstick on the CFO comments and try to spin them in a better light. That does not mean they will be successful in reviving their stock price. Twice in two weeks Google has successfully tested support at $340. Should that level break we could easily see $300 and Google may need to make that trip to satisfy the nervous Nellie's that are in shock from the triple whammy of three drops of -$25 or more in the last month. This is not a stock for those with weak knees and I would bet there are some knees shaking tonight.

Dow Transport Chart - Daily

The Dow Transports rallied on Monday's oil drop to another new high very close to 4500 but gave up ground as profit taking took hold on Tuesday. Financials have also been very strong and had emerged as the new leadership group but they were pounded for some steep losses today. Some of the weakness in financials started late Monday afternoon but accelerated early today. Considering the charts of the new momentum stocks BSC, MER and LEH they are due for some profit taking. Put volume in these leaders is very strong as longs protect their profits and bears enter new put positions. I mentioned this last week and it appears to be catching on in the media as I heard it being repeated twice on Tuesday.

The S&P moved over 1295 but only barely and could not hold its gains. I suggested on Sunday that we should tighten our stops to just under 1295 on any move over that level for fear it would not last. Sometimes the touch of a critical new high is all that is needed to trigger profit taking on any negative news. That is exactly what we saw this week. The market was overbought and stretching its gains and the news provided the excuse to bail. Wednesday's ISM will either be the confirmation the bears are looking for or the pivot point for a new reversal higher.

However the market internals were severely negative with declines beating advancers by better than 2:1. Volume was also high at more than five billion shares. This was a billion more than Friday or Monday. This could have been end of month profit taking as I stated above but given our point on the calendar caution is in order.

March tends to produce some declines in the indexes as the New Year rally fades. In 2005 the high for March was the 7th at 1229 and the beginning of a dip that lasted two months and sank to 1136 or -7.5%. In 2004 the March high came on the 4th at 1163 and that high lasted for eight months. The immediate drop was -76 points with a bounce on March 24th. In 2003 the high was March 3rd with a drop of -64 points by March 12th. This particular drop was a continuation of a sell off that began on Jan-13th at 927 and ended at that March 12th low of 788 or -139 points. In 2002 the March high was 1173 on the 11th, which began a drop that ran for -498 points and ended at 775 on July 24th. That March high was only -3 points from the high for the year set in January. This was a very nice return to the highs of the year after a Jan/Feb decline to produce a sucker's rally followed by a monster decline. In 2001 the March high was set on the 6th at 1267 and ended on the 22nd at 1081 for a -186 point drop. Of course we all remember the March 2000 historic high of 1552 on the 24th that ended on April 14th after a -213 point drop. 1999 saw a -5.1% drop. 1998 saw gains during March but the downtrend reappeared in 1997 on March 11th at 815 and falling to 733 by April 14th for -82 points. 1995 saw only a small drop in early March and was followed by a strong rebound.

Table of March Drops Last Eleven Years

After doing the research on prior March histories I am even more convinced that stopping out of any longs at 1295 was the right thing to do. There seems to be too many undercurrents and the markets were struggling at their highs. That leaves us with a problem about our next entry. If we assume that Tuesday was the March high only a day early and subtracted the -8.9% average drop shown above that would take us to 1182 on the S&P. I think it would be crazy to try and pick a target after only one day of weakness so that is not my intent here. Instead of giving everyone a recommendation to go short I am going to modify my prior suggestion. I am removing the 1270/1275 numbers we have been using and making 1280 our trigger point. We want to be long over 1280 and short below that level. If we do decline significantly I would look to buy the dip at the 1250/1255 level but reverse again to a short under 1250 targeting 1200. I believe the market is overall bullish as evidenced by the financials and transports and any March weakness should be exploited and then used as a buying opportunity after it has run its course. If we do get the historical March weakness it could last until the Fed meeting in late March. Try not to get married to your positions or your bias as divorce is more costly the longer you refuse to admit the position has gone against you. I know this for a fact because March of 2000 was very costly for me and probably still influences my bias six years later. Profiting from the experience of others is always cheaper than experiencing it personally.

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