Option Investor
Market Wrap

Deja Vu

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I feel like Bill Murray in Ground Hog Day. The markets are repeating the same range bound moves nearly every day with attempts at new highs followed by a short, steep sell off. We are locked in a range at the highs with intraday volatility increasing. Economic reports continue to paint a mixed picture and earnings news is doing the same. Because of the conflicting signals we remain trapped in this range bound cycle and doomed to repeat the prior day over and over again.

Dow Chart - Daily

Nasdaq Chart - Weekly

The positive economic news for the day came from a sharp drop in job cuts as reported in the Challenger Report for March. Job layoffs fell -25.7% from February levels. This represented a sharp acceleration in the rate of layoffs that had peaked in November. The following table shows the sharp decrease in layoffs as Q1 progressed. The 64,970 layoffs in March was an 11-month low. This should create heightened expectations for Friday's Jobs Report.

Layoff table

Although the economic calendar was light today the markets continued to anguish over the ISM reported on Monday. The ISM dropped only -1.5 points to 55.2 from 56.7 but estimates were for a strong gain. Consensus estimates were expecting a jump to 57.5 while Moodys was expecting a very strong 58.5. The majority of the drop came from weakness in the new orders component. This suggests the economy was slowing as Q1 ended and this is exactly what the Fed has been reporting. However, even when a slowdown has been predicted the actual arrival always generates concern. Investors worry about the potential strength and duration of any decline. All declines whether minor or major always begin with a marginal dip. Until that dip begins to firm again investors will continue to worry. Economic depressions after lengthy Fed rate hike cycles are especially troublesome. Investors should be cheering weak economics as less risk that the Fed will continue pushing rates higher but there is always the risk that a recession could be heading our way. On Wednesday we will get the ISM non Manufacturing Index and the Risk of Recession for March. The Risk of Recession for February had fallen to 15.2% from a cycle high of 30.7% last June.

The biggest report of the week will be the Jobs Report on Friday. The consensus estimates are for a gain of +195,000 jobs in March compared to a gain of +243,000 in February. Investors are hoping for another Goldilocks number, not too hot and not too cold. Too many jobs and the Fed could continue on its hike cycle past May. Too cold and fears of a Fed induced recession will flourish. The Goldilocks number for March would be in the 150,000-175,000 range, just under the estimates and weak enough to negate the Fed.

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While the broader markets may be range bound the transports are not. The transport index soared another +60 points on Tuesday to close at a new historic high. Pushing the transports higher were strong gains in FDX and UPS as well as the railroads. FDX and UPS are reporting strong package volume, which supports the theory that the global economy is also strong. The railroads are rising on higher commodity shipments also in demand due to a strong economy. The transports have risen over +115 points this week alone. This is even more incredible given oil prices just under $68 on Monday. Strong transports are an excellent leading indicator for a broad market move but the Dow has fallen on hard times and can't get up.

We saw some profit taking in oil prices on Monday after an intraday spike to $67.90. Tuesday's continued pullback to support at $65.50 was met with buying ahead of tomorrows inventory levels. Oil inventories are expected to rise by +1.0 mb, gasoline decline by -1.5 mb and distillates decline by -1.7 mb. Refinery utilization is expected to drop as more refineries take time out for maintenance and to switch to summer products.

May Crude Oil Futures Chart - Daily
(390 min to eliminate bad daily tick)

Oil prices are still being held up by concerns over Iran, Iraq, Nigeria, Norway and of course Venezuela. This week Hugo Chavez seized oil fields owned by France's Total and Italy's ENI after they refused to go along with the new nationalism of oil assets. This is simply another step by Chavez to take back energy assets from those who paid for them under the mid 1990s energy privatization plan. Under this plan foreign oil companies were induced to invest in Venezuela in order to modernize their production capabilities. Those companies invested over $25 billion after VZ entered into agreements with the major oil companies. In 1999 production had spiked significantly under the new arrangement, just before Chavez took office, to 3.8 mbpd with a goal of 6.0 mbpd. When Chavez took office and began canceling these prior agreements production began to decline simply because companies did not want to risk more capital in an unstable environment. Production today has declined to 2.6 mbpd, -31%, and is continuing to decline. The fields seized this week produce more than 115,000 bpd but without continued investment they will also begin to decline. Exxon, Total and Statoil still have facilities that produce 330,000 bpd and are at risk. Venezuela is thought to have proven reserves of 80 billion bbls, about 34 billion of which are extra heavy crude deposits that must undergo special refining before being marketable. Exxon, Total and Statoil are the three principal refiners of this oil. It is also thought that VZ has an additional 235-250 billion bbls of extra-heavy crude that would make them the largest oil reserve in the world if these reserves were proved. Unfortunately oil in the ground is just a hope for the distant future if there is nobody left to extract it compared to real money for VZ if the majors had been left to run their own business.

For America the drop in VZ production from 3.8 to 2.6 mbpd is a challenge. VZ is the third largest exporter of crude to America. A tanker from VZ can make a round trip to the U.S. in 10-11 days. A tanker from Saudi Arabia takes 90-100 days to make the same round trip. According to Matthew Simmons, Higo Chavez is a time bomb. At any moment he could refuse to sell oil to the U.S. and force us to rely more heavily on the Middle East. Chavez understands the chokehold he has on the U.S. and will eventually play his trump card. Chavez is up for reelection this year but massive funding of social programs makes him the likely winner. Venezuela is the third largest importer to the U.S. making up 12.1% of our total consumption. If this supply was suddenly cut off the short-term results could be disastrous. The almost daily news items from the Venezuelan oil front is helping to support crude prices.

Table of U.S. oil consumption by importer

Our fourth largest importer, Mexico, is also having its share of troubles. President, Vicente Fox, said production at the huge 11.5 mb Cantarell oil field is declining sharply at about -6% per year with expected output of 1.9 mbpd in 2006. He said the rate of decline is accelerating and should decline even more sharply in subsequent years.

Conoco released its first quarter projections today and said production totals would be similar to Q4 at 1.9 mbpd excluding its Lukoil operations. Lower production in Alaska, Norway and Nigeria would offset gains in Australia and the U.S. mainland. They also said the 247,000 bpd refinery at Belle Chasse, Louisiana had failed to restart and could be offline another 2-4 weeks. This refinery has been offline for seven months after being damaged by Katrina.

The price of gasoline has been giving support to oil prices almost as much as the geopolitical concerns. The shortage of ethanol is making news daily as is the lack of any high volume transportation method to the coasts. Ethanol is largely produced in the Midwest and must be shipped by rail, truck or on barges to the coasts to supply the refineries. There appears to be a real crisis brewing as the switch from MTBE to ethanol approaches. The price of gasoline is rising as users try to lock in supplies ahead of the conversion to prevent any shortage during the summer driving season. After the conversion ethanol will make up 10% of each gallon of blended gasoline. America burns nearly 60 million gallons of gasoline per day. That will require a huge amount of ethanol. Valero estimates 150,000 bbls of gasoline per day will be taken out of production by the new rules and the inability of some refiners to comply. Nobody knows yet how the switch to ethanol will impact summer prices but you can bet prices will not go down. Archer Daniels midland (ADM) and Pacific Ethanol (PEIX) have seen their share prices soar on the expected increase in demand.

The Colorado State Tropical Meteorology Project updated its hurricane forecast for 2006 today. They are currently predicting 17 named storms of which 9 will be hurricanes with 5 of them category 3 or above. I am sure this is exciting news for those workers in the Gulf who are still working to repair damage from the 2005 storms. The hurricane season begins on June 1st.

We need a hurricane in the equity markets to shake something up and produce a trend we can trade. The current topping out process is teasing the bulls with hope of a breakout while punishing the bears that are shorting and hoping for a breakdown. Longs are not working and shorts are not working for more than intraday trades. It may appear that I spent a lot of time on energy today but energy, banking and transportation are about the only sectors with a directional trend unless you call sideways a trend. The major indexes all closed higher today but the volume was lackluster and the advance/decline was barely positive. The Nasdaq managed to close at a new five-year high but it was only a technical point. The Nasdaq has traded higher than today's close on each of the last four days but it failed to hold those levels.

Chart of Semiconductor Index - Weekly

Handicapping the Nasdaq is once again the Semiconductor Index. For a month now the SOX has traded sideways in the 495-515 range and it can't seem to breakout for a credible move. Monday's semiconductor billings declined by -2.2% and a sharper decline than the -1.5% drop in the prior month. The chip bulls can't seem to find any traction and Intel is scheduled to report earnings, or the lack thereof, in just two weeks. Intel closed at a new three year low on Tuesday at $19.30. Micron, Motorola and Texas Instruments are trying to support the sector but are finding no help among their brethren. This chip weakness is keeping the Nasdaq from moving higher.

Also producing a drag on the Nasdaq is the lackluster Dow. The blue chips can't get out of their own way despite strong gains in the commodity and manufacturing stocks like CAT and MMM. Citigroup, JPM and AIG also supported the Dow but the result was lackluster. The only successful trend on the Dow for the last two weeks has been to short the rallies. We have seen two weeks of progressively lower highs punctuated by some very strong swings but the trend until today was still down. Tuesday's low was NOT a lower low and that could be telegraphing a change in the trend.

The end of month tape painting went awry with the Google S&P announcement. Index funds were forced to buy $7 billion in Google shares and reduce holdings in the other 499 stocks by a like amount. This caused havoc for the tape painters who would normally be buying shares to prop up the index rather than selling them. We did see a nice bounce on Monday but that was quickly sold as the latecomers used the bounce to continue squaring those S&P adjustments. Today's bounce was not sold in volume and that does suggest the program traders are as confused as we are about direction. On a positive note the lack of end of quarter window dressing also produced a lack of undressing this week. This is a positive sign as it means funds are still comfortable with their positions.

USA Today featured an article this morning about the current bullish streak and the potential for a disruption ahead. According to the article we have gone 373 days without a -10% correction. According to the author this was approaching the second longest streak on record for the modern era. As we move closer to summer this fear of a potential correction is growing. With the yield on the ten-year note near 5% it provides an attractive alternative for equity investors afraid of future market risk.

With the Dow near its highs and not making any material gains investors are becoming worried. However, they are overlooking market signals from other more reliable indexes. The NYSE Composite, $NYA.x, is composed of just over 2000 issues and represents more than 77% of public capital traded. It also represents more than 61% of foreign capital traded. The NYSE Composite closed at another new historic high on Tuesday and is showing no signs of weakness. The Wilshire-5000 (DWC) also closed near a new high and although it is pressing uptrend resistance it is showing signs of a potential breakout ahead.

Chart of NYSE Composite - Weekly

Chart of NYSE Composite - 180 min (same uptrend resistance)

Chart of Wilshire 5000 - Daily

While I am not comfortable with the conflicting signals across all the indexes there are ample reasons to suspect we could move higher. Going against this outlook is the fact we are in the middle of earnings warning season and bad news could break out at any moment. We have seen numerous warnings from various sized companies but mostly the small fry and nothing really notable has surfaced. If the warnings cycle continues this bland then investors should start expecting better results for the Q1 cycle and expecting an old fashioned earnings run. This could attract those buyers on the fence and break us out of the current range. That is a lot of "ifs" but at least you understand the scenario ahead of us. Keep your eye on conversations about the Jobs report and be prepared to trade the trend if one develops.

For those of us who have lived with the imperfections in the QCharts program for years there is help on the way. Most of us have continued to use QCharts because of their extreme ease of use despite sporadic problems with data integrity. I received notice today that eSignal had acquired the QCharts platform. ESignal has one of the most reliable data feeds in the market and I am looking forward to the integration of their feed into the QCharts system. Our patience has been rewarded!
 

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