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Market Wrap

Bad News Bulls Loose Again

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Bad economic news and negative comments from a couple Fed heads provided a wall of worry for the markets to climb. On the surface it appeared the bad news bulls huffed and puffed and charged over the wall of worry with no real signs of fear that the economy was stalling. Of course the Dow was helped by three buy programs that added +96 points to the day's gains. Since the Dow closed with only a +75 point gain for the day we see that retail buyers did not rush into the market and the Dow actually gave back -21 points of those program gains. To put it another way, without the three buy programs the Dow would have finished -21 points in the red. Does this negate the days performance? Not in my opinion but it does make me very cautious as the Dow and S&P test new highs.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

Economic reports today showed enough weakness to break the cycle of selling in bonds that sent yields soaring to two-year highs over the last two weeks. Leading the list of weak reports was the Retail Sales for February. The headline number dropped -1.3% compared to a +2.9% gain in January. Consensus estimates were for a smaller drop of only -0.7%. Auto sales declined as expected but sales ex-autos were also down -0.4%. Building supplies and grocery stores were the only standouts in the list. The decline in the headline number was the first decline since August 2005. Despite this decline it is important to realize that year over year growth is still up +6.7% overall or +8.9% excluding auto sales. January sales were above normal due to the exceptionally warm weather that encouraged shopping. February saw two weeks of very cold weather accompanied by a severe snowstorm in the northeast. I warned last month that the February numbers would be impacted by that return of winter weather.

The U.S. current account deficit increased to a new record of -$224.9 billion for Q4-2005. This was a sharp increase over the Q3 deficit of -$185.4B. The Q4 deficit represented 7.0% of GDP with the entire year rising to 6.4% of GDP up from 5.7% in 2004. To put today's Q4 deficit of -$224.9 billion in perspective it is nearly three times the -$86.1 billion we saw in Q4-2001. The numbers are accelerating sharply to the downside and the only way this will be resolved is by a substantial slowing of consumer demand for foreign products. This will only come in one of two ways. A serious recession that limits consumer funds due to rising unemployment, depreciates the U.S. dollar and raises the cost of foreign products. Or, a rise in production of American products priced cheaper than those now acquired from overseas manufacturers. Obviously we know which of those events is more likely to occur.

Business Inventories rose at a stronger than expected +0.4% rate in January following an upward revision to +0.8% in December. Retail inventories rose +0.5% while business sales rose +1.3%. This pushed the inventory to sales ratio to a new historic low of 1.24 in January. This is the lowest level since records were initiated in 1992. Excluding autos total business sales for January rose +2.5% and the strongest rate since May 2004. Overall this surprising build in both inventories and sales supports the assumption that the economy is growing faster than previously thought and we could see an upside surprise in Q1 GDP.


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The Job Opening and Labor Turnover Survey (JOLTS) showed that new hires rose and separations declined in January. This is not a surprise after last weeks Jobs report. However, the Manpower Survey also released today showed that employers in 23 of the 24 nations surveyed expect to add employees in Q2-2006. This supports the assumption that the global economy is booming and not just the U.S. economy. The strongest surge in hiring expectations came from the Asia-Pacific region led by strong hiring prospects in Japan. According to Manpower the net hiring prospects in the U.S. jumped from +13% in Q1 to expectations of +24% in Q2. The strongest employment trend came from Japan where +43% of employers are expected to add workers followed by India +40%, Taiwan +31%, Peru +31%, New Zealand +26%, Hong Kong +25% and China +21%. Those numbers are derived from the percentage of employers expecting to add workers minus those expecting to reduce workers. For example 16,000 employers were surveyed in the U.S. with 30% planning on adding workers and 6% planning on reductions. This produces a net employment outlook of +24%.

I think this shows why oil prices are going to continue higher on a long-term basis. The two largest countries in the world, China at 1.3 billion and India 1.03 billion, have a net employment outlook of +21% and +40% respectively. Jobs require energy and 23 of 24 countries surveyed currently have a positive hiring outlook. While this is good news for energy bulls it is not what is driving oil prices today and prices are nearing resistance at $63.50 once again. The decline of last week has been forgotten with a nearly +$4 gain over the last two days. The Nigeria problem continues to push prices because the -450,000 bpd of production now offline is light sweet crude and the commodity that refiners need most. Worries that rebels will make good on their promise to take one million bpd offline are keeping a floor under prices. OPEC's president, Edmund Daukoru, said in Abuja on Tuesday that OPEC would support a new price band from the high $50s to the lower $60s. They are doing an excellent job of managing the price however we may be coming to an inflection point. Today the IEA reduced their growth estimates for OPEC crude for 2006 by -300,000 bpd to 29 million bpd. The EIA lowered their forecast to 29.7 mbpd from 30 mbpd. This is for all of 2006 and averages the high and low seasonal demand cycles. Currently the OPEC production quota is 28 mbpd plus any Iraq production currently around 1.5 mbpd. The reason for the lowered demand "growth" estimates is demand destruction due to price. Even the lowered numbers are still an increase over last year's levels so we are talking about different views of "growth" rather than a drop in actual demand. The reason given for demand destruction due to price is the price controls in many Asian countries. Prices are set by the government and many countries were selling gasoline and diesel below cost last year. Since this is not the recipe for a long-term solution the governments have reluctantly raised prices. In these countries the average income level is equivalent to that of a panhandler in New York so any rise in fuel prices is a major blow to those with subsistent incomes. However, those nations also are very small consumers of oil compared to the rest of the world. The top six consumers are USA 20.7 mbpd, China 6.5, Japan 5.4, Germany 2.6, Russia 2.6 and India 2.3 mbpd. Those countries are not seeing any material demand destruction due to price. Most analysts believe any decline in consumption in the smaller nations like Indonesia, Thailand and Vietnam where controlled prices have been raised will easily be offset by consumption gains in China and India.

Crude Oil Chart - Daily

Prices are rising on the Nigerian worries, threats from Venezuela, new decline numbers from Mexico's giant Canatrell field and a growing fear that the U.S. or a coalition of countries will take action against Iran. The UN Security Council is stalemated on the Iran issue with Russia and China as the stumbling blocks. Neither wants to risk angering Iran and losing their business or oil/gas exports in the case of China. The betting sites are now showing a 2:1 line that the U.S. and friends will take action against Iran outside the UN. Iran raised the oil card again as tensions began to rise. We are also facing a new blend of gasoline and diesel as summer begins and that is pushing fuel prices higher. Oil closed at $63 and natural gas rose to $7.20. On Wednesday OPEC will release its monthly demand forecast and it could spell the end of the price spike if it shows a sharper reduction in demand estimates than the IEA/EIA. However, wouldn't it be in the best interests of OPEC to estimate high in light of their current price management program? Estimating higher demand growth than the IEA/EIA would keep the bulls at the trough and prices stable.

Despite the rise in oil prices the markets rallied to new highs on the Dow and S&P. Unbelievably even the transports rallied +40 points and very close to a new high. This is a sure sign that growth tops interest rates and oil prices. There were also some negative comments from a couple of Fed heads that were ignored. Bernanke said "long term rates were still quite low." That does not sound like a comment from somebody that is anticipating an end to rate hikes soon. Surprisingly the markets took it as a positive that rates were still low and would allow the economy to continue growing. Richmond Fed President Jeffery Lacker said that inflation was at the high end of the acceptable range. This was another remark that suggests the Fed is far from done. Lacker has mentioned several times recently that he was concerned about the rising core rate of inflation. Even before these comments from the Fed heads the expectations for further hikes had risen. Current expectations are now for at least two hikes and a better than even chance for a third in June. The next Fed meeting is only nine days away on March 23rd.

Ten Year Note Yield Chart - 60 min

Bonds reacted to the economic news with a sudden halt to the selling that had pushed yields to two-year highs at 4.793% on the ten-year note. A combination of very oversold conditions, short covering and the negative economics combined to knock the yield back below 4.7%. In bond terms that is a huge move. It was the biggest one-day decline in over six months. Those fearing that yields would hit the 5% level and the death knell for stocks breathed a sigh of relief. There was also a report from a rogue research firm that the Fed was going to halt rate hikes sooner than most mainstream analysts believed. That report added fuel to the bond fire despite being given little credibility. The dollar also got sold on the news of the deficit hitting 7% of GDP. There were also rumors suggesting Arab central banks were moving assets out of dollar denominated accounts in advance of a showdown on Iran. It was a busy day in the markets regardless of the type of action you watch.

Financials soared after Goldman Sachs reported earnings that exploded +62%. Goldman stock jumped +8.70 to $149.42. This sent the other financials flying on hopes their results would mirror those from Goldman. One analyst felt differently and said Goldman probably "had a hunch and bet a bunch" and that made their quarter. Time will tell but the banking sector soared as a group and sent the S&P to a new 4.5-year high. Financials represent 20% of the S&P. Bear Stearns and Lehman are scheduled to report later this week.

Goldman Sachs Chart - Daily

We have a strong economic calendar the rest of the week but after Tuesday's bad news bounce there may not be anything in the reports that will produce a surprise. The Dow has rallied back to the 11160 mark and +3 points higher than the February high. This is exactly where a strong breakout or critical failure should occur. We saw this level tested on Feb-22nd followed by three weeks of consolidation. At the time techs were diving and the Dow was diverging sharply. This time around the Nasdaq has rallied +54 points from Friday's support test of 2240 and techs appear strong. The Nasdaq tacked on +28 points on Tuesday and is nearing the 2325 resistance highs once again. One more good day should do it but the real point here is the agreement among all the indexes with the exception of the SOX. While the SOX did post a gain on Tuesday of +11 points it was off a two month low. The SOX is lagging for a number of reasons but that bounce off Monday's low of 500 could be the bottom for this cycle. The risk immediately ahead is the semi book-to-bill due out on Thursday night. If we see another slowdown in chip orders that support at 500 could break and take the Nasdaq with it. Until then we have a remarkable confirmation of all the other indexes.

NYSE Composite Chart - Daily

The NYSE Composite sprinted to a new all time high on Tuesday at 8200 and never looked back. The Russell gained +8 points but is being held back by the same SOX as the Nasdaq. The charts of the Russell and Nasdaq could be laid over each other and would be indistinguishable. The Wilshire 5000 closed only -30 points from a new historic high after five days of gains. The transports came within -4 points of 4500 and very close to a new historic high. The S&P hit 1298 intraday and closed only a point off of that high.

It appears the fix is in and the bulls are ready to stampede. Advancers beat decliners 5:2 and up volume was nearly 4:1 over down volume. However, it was not a high volume day at 4.6B shares. It was luke warm but not exciting. Much of that was due to the three program trades I mentioned above and their impact on the shorts. I would like to think the markets are about to breakout and sprint higher but I remain cautious until the breakout actually occurs. I mentioned earlier this is exactly the spot where the breakout should occur but the Dow did spend more than a week at this level last time and eventually failed. The S&P has a serious hurdle at 1300 and while I would love to celebrate a success there it has not happened yet. I believe traders don't know what to hope for as the economic calendar unfolds this week. Do we want bad news to pressure the Fed to halt the hikes or good news showing the economy is exploding and can handle a few more hikes? I think I would like to see positive economic news. Economic growth can and does ignore rates as long as they are not abusive. Our current 4.5% is far from abusive and a 5% GDP for Q1 would be a nice recovery from the hurricane dip in Q4 and a number the Fed could live with. Everyone following my recommendations should be long from SPX 1280 and it would be nice to see a breakout on this third test of 1295.

Beware the OPEC demand forecast tomorrow as it could generate profit taking from the current oil bounce. While falling oil prices would be good for the overall market it would be detrimental for those of us long the bounce. Hopefully as we move into the latter half of March, oil prices should have less incentive to decline as we approach the seasonal demand bounce. The focus for the broader market will become the Fed meeting on the 23rd and that could produce a drag on equities if the economic reports this week suddenly turn cheerful. I know it is tough to decide what to wish for but we are not alone. That indecision for the markets could arrive soon and the waiting game for the Fed meeting begin.

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