The rally to new multi year highs over the last ten days finally rested on Tuesday. The market shine of new high glory faded as the indexes retreated from intraday highs and returned to lows not seen in a week. While it sounds grim the selling was calm and reserved despite its persistency. The Dow only lost -39 points according to the closing ticker. That would seem to be non-threatening for the bulls but in reality it was slightly worse. The loss was more significant if you count the evaporation of the +57 point intraday gains in addition to the -39 point close making a -96 point drop from the new intraday high at 11334. The -19 on the Nasdaq and -7 on the S&P both carry similar intraday losses.
Dow Chart - Monthly
Nasdaq Chart - Monthly
The markets were mixed on Monday in advance of the Bernanke speech and while the speech provided no excuse to rally the markets opened higher on Tuesday but only barely higher. It was not until some strong buy programs hit the futures pits at 11:30 that the markets began rising sharply. The buy programs sent the Dow, Nasdaq, S&P, Russell, Wilshire 5000 and the Dow Transports to new multi year highs. Only the NYSE Composite failed to join the party. The intraday spike to those new highs failed and the resulting drop produced what is called a negative outside day and suggests there could be more selling in our future.
The morning economics provided no reason to rally and traders were at a loss as to why the buy programs appeared. The only major piece of economic news was the Producer Price Index or PPI. The headline number posted a huge drop of -1.4% in the price of finished goods. On the surface this would appear to be good news for the inflation hawks. This was the sharpest drop in the last three years. However, as you know the headline number does not always tell the story. The core rate excluding food and energy actually rose +0.3% for finished goods and +0.5% for intermediate goods. This rapid rise in core inflation was in addition to a +0.4% gain last month in finished goods and a larger +1.0% gain in intermediate goods. The positive impact of a falling headline number was trumped by the core rates.
This put the Bernanke speech back in focus with the next FOMC meeting only a week away. Despite his attempt to explain away the current low long-term interest rates the outlook for the Fed is for further hikes in rates. The rising core rate of inflation is a key signal for the Fed and after last nights speech the majority of analysts are still thinking we will see 5.0% in May and possibly higher. Bernanke offered several scenarios that could lead to a lower Fed rate and halt to rate hikes. None of those scenarios are readily apparent today. The various Fed heads have taken up the new mantra of "data dependent" instead of the tired "measured pace" phrase. If we are truly going to be data dependent for future hikes once a neutral position is achieved then everyone is eagerly awaiting that neutral position, which is commonly expected to be 5.0%.
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Bernanke said a lower rate could become neutral if falling yields are really signaling economic weakness ahead. Nobody will admit to this being the case and cite other reasons for the abnormal yields. The number one reason given was treasury buying by foreign central banks and the shortage of bonds for sale. While I am sure the government is going to sell some more notes to continue financing the deficit there is actually competition for those debt instruments. Bernanke said in this environment the very flat yield curve was not signaling a recession ahead. His speech did not give traders a reason to buy or sell stocks, as it was very balanced ahead of next weeks meeting. If anything it produced some selling in bonds because it was so neutral. The yield on the ten-year note jumped from 4.646% to 4.729% on strong selling after the speech. This almost erased the sharpest drop in the last six months we saw last week. Buy the rumor, sell the news.
Now that Bernanke and the PPI are behind us the markets are left to focus on the housing data coming on Thursday and Friday. If the Fed is going to be data dependent this is the next piece of material economic data ahead of their meeting on Tuesday. The data will probably not impact their decision for next week but sets up the next meeting in May as the critical end point.
The sectors showing the most weakness today were those with the biggest recent gains and those interest sensitive issues. The homebuilders continued their swoon that started on Monday after a six-day rally. Clearly traders were taking profits ahead of the monthly numbers due out later this week. The incentive for the early exit was the jump in the ten-year rates. The brokerage sector gave up early gains and several brokers closed back on critical support with a negative setup for tomorrow. Lehman (LEH) would be an example with a loss of -$3.27 to support at $142.
Chart of Lehman - 30 min
Speaking of brokers the portfolio manager for Merrill with $570 billion in stocks under management said today that the economy is going to slow due to slowing consumer spending. This was the same train of thought I tried to convey in my Sunday commentary. His advise to investors was to overweight energy stocks. I like this guy more every day. He said despite the decline in oil prices this week the price of oil should continue to hold at these high levels and continue to produce profits for the energy companies. Most of the oil companies are trading at extremely favorable ratios. For instance Conoco has a PE of 6.26 on a trailing basis. Despite soaring prices for energy stocks last year their profits have risen even faster leaving their valuations very low.
While on the topic of oil prices I want to comment on Monday's drop. I believe it was purely expiration driven. The current April contract ceased trading today and May became the current contract. We saw prices soar into Friday's close just under $64 as options expired. We saw the actual price of oil crash on Monday as traders still long bailed out rather than be forced to take delivery. It is one thing to speculate in oil futures but an entirely different matter to be faced with taking delivery of the product. The April contract closed at $60.40 and the May contract was two dollars higher at $62.30. It was simply a matter of expiration and delivery manipulating the prices. Once we see how the new May contract trades this week we will have a better idea about the future of oil prices heading into the summer. Support on the May contract is $61.25 and resistance at $65.50. For comparison purposes the December contract, post hurricanes, summer driving and winter heating demand, closed at $66 today. As in options trading the more time you buy the more expensive the premium.
April Crude Chart - Daily
May Crude Chart - Daily
December Crude Chart - Daily
China bought a lot of time today with three different deals for Russian oil and gas. It will take a long time for them to reap the rewards because of the time needed to build pipelines but it was a major agreement for Russia to supply oil and gas to China's hungry horde. I would rather see China and Russian fighting it out over energy a decade from now rather than have China imposing its will on Canada or Mexico. Let the two bullies trade blows and we can watch from afar. Remember, Putin likes free markets anywhere else but in Russia. He recently hiked prices of natural gas and then cut off that gas when the consuming countries threatened not to pay. Cutting off oil/gas supplies to China would have dire consequences.
The SOX was a major factor in the Nasdaq today as a large block of those early morning buy programs targeted the chip stocks. This appeared to rescue the SOX from its two days of sideways trading under 500. The rally sent the SOX from 497 to just over 510 but the hang time was very brief. The decline was about as rapid as the ascent with a close right back at its 497 start. Intel heads the problem list for the SOX. Intel is expected to miss estimates when they announce earnings on April 19th and the stock declined to a new two year low of $19.39 on Friday. Today's buy program spike added a buck intraday, a +5% spike, but it was almost completely erased before the close. INTC traded 124 million shares and +50% more than the current 80 million daily average. This scenario was repeated across the other leading chip contenders as shorts were stopped out and then reinstated their positions. Unless something positive happens soon the Sox is going to lose its grip on 500 and begin targeting real support back at 450. This would be very detrimental to the broader market.
SOX Chart - Weekly
Microsoft Chart - Weekly
After the close today Microsoft announced their new Windows operating system expected out this year would now be released to consumers sometime in 2007. This is the new Windows product codenamed "Vista" and the one the hardware makers were hoping would produce a new wave of PC buying. Hardware makers had hoped it would be out in time to spark that new buying during the holiday season. The new release will contain an updated user interface, better security features and a new search tool for finding information stored on your PC. The product was expected to power Microsoft's next round of profits and the delay will force analysts to lower earnings estimates for 2006. MSFT shares dropped nearly a buck in after hours trading and should give the markets a negative push at tomorrow's open since hardware makers and chip suppliers will also trade down on the delay.
Tuesday's spike and retracement had all the earmarks of a blow off top or climax spike. This is typically seen when a rally runs out of steam and traders park sell orders just over the prior highs in hopes of maximizing profits on longs and switching to the short side for a potential correction. With earnings warning season upon us there is more potential for downside risk than upside surprise. The guidance given with the Q4 earnings was weak in many cases and traders are probably not very confident that Q1 earnings will be strong. This sets up this week as a soft spot with nothing to provide guidance but warnings and guessing about next week's Fed meeting. For three days the indexes have struggled only minutely higher and todays buy program spike provided the entry point the shorts were looking for.
I showed you on Sunday that the Dow was trading just below the resistance from 1999-2001 between 11328-11418. This is a very strong resistance level and a likely place for more consolidation until the Fed actually halts the rate hikes. Today the Dow hit 11334 and triggered sellers waiting at the beginning of that resistance band.
The same was true with the Nasdaq and the touch of 2332. That was the previous high of the year from Jan-11th and both days were just four points over the May-2001 resistance high at 2328. This was a critical level and the breakout failed. The same thing was true of the S&P at just over 1310. For four days the S&P has struggled at 1310 resistance and only -4 points under the 1315 resistance high from May-2001. Today the S&P spiked +11 points intraday to break 1310 one last time and set a new 4.5 year high by less than half a point before crashing back to earth with a close at 1297.
SS&P Chart - Weekly
SPX Chart - 60 min
These spikes to new highs and subsequent failures back to lower lows produced a negative outside day and a technically negative bias. Whether the markets will follow that bias or fight back on strong dip buying remains to be seen. Given the strong rally off the early month lows the odds are strong that the negative bias will continue. There is simply nothing visible on the horizon for Wednesday to provide positive momentum. Because of our stall at 1310 and Monday decline the morning buy programs could have been tailored to trigger short covering in hopes of breaking the stalemate with a move higher. Instead the spike gave shorts a perfect entry point and a nice sled ride down. I would continue to maintain a negative bias until proven wrong. The S&P has light support at 1295 but the Microsoft news has already depressed the futures to that equivalent level in overnight trading. A break of 1295 could see another -10 point drop or more before support returns around 1280. This is a throwaway week ahead of the Fed meeting and three weeks before Q1 earnings begin. This is a week for earnings warnings and some potentially market moving housing data on Thr/Fri. I would not be in any hurry to get long again until after the FOMC meeting. The exception to that would be to buy the dip in energy in hopes that traders switching to the May contract provide lift for energy prices.