Last Tuesday I mentioned that we were stuck in a range bound market and forced to repeat that range on nearly a daily basis. That range has collapsed and we could now be experiencing the start of an old fashioned correction. Critical support levels have failed and market internals are very negative despite strong earnings from the early reporters. Analysts are pinning the blame on the interest rate donkey and inflation caused by a rise in commodity prices.
Dow Chart - Daily
Nasdaq Chart - 120 min
There were no material economic reports leaving the Job Openings and Labor Turnover Survey (JOLTS) as the sole economic focus for the day. The JOLTS survey showed that the hiring rate of +3.7% was unchanged from February. The number of gross jobs increased to 4.972 million, up from 4.941 million. The number of available jobs rose to 4.054 million and a post recession peak. Job openings have grown substantially faster than the number of hires by +16% over the past year. Gross job creations at 4.972 million was almost exactly the level reached just before start of the 2001 recession. Voluntary separations (quitters) have also been rising due primarily to the abundance of new job opportunities. Overall the jobs picture remains healthy but with an economic slowdown expected later this year it could tighten up again as summer begins.
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Without any material economic reports traders were left to focus on news events and a few earnings reports. The markets opened higher on the outstanding earnings news from Alcoa but that enthusiasm was quickly lost. Letting the air out of the opening bounce was news out of Iran that they had successfully enriched uranium using centrifuges. The news was initially broken by the past Iran president and then the current president announced it publicly. The current president said "Iran will soon join the club of countries possessing nuclear technology" and "Enemies can't dissuade the Iranian nation from the path of progress it has chosen." The market imploded on this news as reports from numerous other sources claimed the US was accelerating its plans to bomb Iran to prevent them from manufacturing a bomb. The Dow dropped -111 points from its opening highs in less than 60 min as the news sources repeated the news over and over.
Crude Oil Futures Chart - Daily
Ironically oil prices also imploded from their overnight high of $69.45. Despite the potential for an oil crisis from any Iranian action the prices fell to $68 intraday sending energy stocks plummeting. Stock downgrades based on price also caused havoc. Frontier Oil fell -3.81 today stretching its loss over the last four days of downgrades to -$8.00. Other energy stocks with major losses included DO -2.86, AHC -2.54, TS -2.49, HAL -2.33, GI -2.15 and RIG -2.04. Energy stocks saw a minor rebound towards the end of the day when oil futures erased their losses and rebounded to $59.10 at the close. It was surprising that oil did not move substantially higher on the Iran news but traders said the rise from $61 to $69 over the last three weeks had already factored in the potential for a continued Iran problem. We also have the oil inventories out on Wednesday and traders were cautious ahead of the numbers given the recent gains.
The Energy Information Agency (EIA) announced that the average for a gallon of gas for this summer would be somewhere in the $2.62 range. Since gasoline is already well over that on both coasts the news was greeted with skepticism. Their estimates were based on $65 oil and today's close at $68.95 already negated their analysis if prices continue at that level. We also heard that higher prices have not decreased demand and actual demand is expected to increase +1.5% this summer. AAA predicted that gasoline could rise another +10-20 cents by Memorial day if inventory levels continue to decline. That would put gasoline over $3.00 in many areas. Gasoline inventory levels are expected to drop by -2.1 million barrels in Wednesday's report. Commercial distillates are expected to drop by -1.4 million bbls.
Part of the pressure on gasoline prices is due to the rise in ethanol prices. Ethanol has recently traded in a $1.15-$1.25 per gallon range but the May deadline for switching from MTBE has sent spot prices as high as $2.50 per gallon. Prior to the rule change from MTBE to ethanol US manufacturers produced 4 billion gallons per year. With the rule change 3 billion of those gallons will now be burned as a gasoline additive leaving other users in serious trouble. Ethanol imports will be the key until the 33 US plants currently under construction are completed. Last year we imported 31 million gallons from Brazil but it is not cheap. The US imposes a 54-cent per gallon duty plus an additional 2.5% tax. That amounts to $17 million in duties on the Brazil imports alone.
Oil inventories are expected to rise +1.2 mb despite growing worldwide supply problems. Production from Iraq has fallen to the lowest level since the war began. Continuing problems in Nigeria make it doubtful that they will be able to increase production by month end as they forecasted over the weekend. 25% of their light crude is currently offline. We still have -300,000 bbls offline in the Gulf of Mexico due to the 2005 hurricanes with the 2006 season only a little more than a month away. For those interested there is a great new series on the Discovery channel called "Oil, Sweat and Rigs" that chronicles the efforts to repair the damage in the Gulf. It is very informative for people wanting to understand the challenges of offshore drilling. Also, don't forget that Hugo Chavez has pledged to support Iran in the current nuclear conflict. He has said he will take his oil offline if the U.S. attacks Iran or Iran halts exports to pressure the world to let them continue their nuclear ambitions. Saudi Arabia's Crown Prince Sultan bin Aziz-Al-Saud said in a public speech that Saudi was spending $50 billion to increase production capacity to 12.5 mbpd from the current 9.5 mbpd. No timetable was given but prior sound bites project 2010-2012. Matthew Simmons doubts this capability given the decline of their aging fields. They do have about 100 rigs active or planning to be active compared to an average of 15-30 over the last decade. We know they are searching for new oil but there has not been any news of new discoveries.
We saw news bites from two different homebuilders on Tuesday. D.R. Horton said quarterly orders rose +10% but the average sales price fell on softer demand for more expansive homes. Horton said it recorded 15,771 orders for new homes in the quarter ended on March 31st. This was higher than the 14,401 seen in the same quarter in 2005. Orders were up in every market except the Midwest, which saw a decline of -32%. The value of those new orders rose +7% to $4.4 billion. They said slower homes in the $1 million range contributed to a -10% decline in the average sales price in the Mid-Atlantic region, -4% in the West and -5% in the Southeast. Average selling prices rose +11% in the Midwest and +2% in the Southwest. To put all the numbers in perspective the comparisons were made against historic highs in 2005. Sales growth has slowed for Horton to +26% in Q3-2005, +16% in Q4-2005 and +10% in Q1-2006. The declining sales have been dramatic but it still represents gains over those record 2005 levels. The CEO of Toll Brothers was interviewed on CNBC today and he was very positive on sales trends. He confirmed that average sales prices were softer due to added incentives they had not needed to use in 2005. Toll is about to start development in New York and said interest was very high. Toll Brothers said there were still some areas where buying interest was very high such as Arizona and Las Vegas. For instance homes are being sold by lottery in Arizona where orders far exceed capacity. It should be noted that none of the homebuilders have warned for this quarter. Also, recent comments from Fed members suggest the rate hike cycle is near its end. This would be favorable for a rebound in the housing market.
Alcoa started off the earnings cycle with a bang beating the street by a mile. They posted earnings of +70 cents compared to analyst's estimates of 51 cents and more than double the 30 cents earned in the same quarter in the prior year. Alcoa shook off higher commodity prices and higher prices for energy and posted a record quarter. The outlook for the future is more of the same. The global economic boom is proving to be very good for Alcoa. AA closed the day well off its highs but still up +1.26 for the day.
The good news at Alcoa rubbed off on Caterpillar with CAT gaining +1.21 on a down day. Traders are expecting some more good news when CAT announces on April 24th. I would not get very excited about CAT's chances. Higher prices for steel, tires and energy could offset strong sales potential. We have heard in the past that CAT could not make equipment as fast as they can sell it. That may be the problem again this quarter.
Genentech reported earnings after the close today and a +48% jump in income. DNA earned +46 cents for the quarter beating the street by a nickel. Genentech's earnings came from strong sales of its cancer medicines especially Avastin. Avastin cuts off the blood supply to tumors and has been proven to extend life of those afflicted. Unfortunately is costs $4,400 a month. Sales are expected to reach $2 billion over the next several years. Sales of lung cancer drug Tarceva rose +94% and asthma drug Xolair +46%.
S&P announced after the close that Legg Mason would be added to the S&P-500 replacing Guidant, which is being acquired by Boston Scientific. LM had a rocky Tuesday losing -2.73 and breaking support at $124 to close at $122.71. After the announcement LM rebounded to touch $127.40 but settled again at $126. Tough news for those investors who threw in the towel today and sold after a -$16 decline over the last month.
Now that the Q1 earnings have started the battle of the conflicting estimates is in full swing. I reported last week that Thomson Financial was expecting an end to quarterly double-digit earnings soon. Today they announced a new outlook suggesting we could have DD earnings through Q1 of 2007. You can't tell the reports without a scorecard and there are so many qualification it is hard to tell which is which. Rather than try to contrast the various ways firms estimate or calculate earnings lets just say that estimates are improving with only 6% of the S&P reported for this quarter.
Despite this improvement in estimates the stock market appears ready to call it quits. I mentioned last week the potential for a correction in our future given the age of the current rally. Last Tuesday I mentioned the USA Today article showing a 373-day streak without a -10% correction on the S&P. That streak has now grown to 380 days but we could be nearing an end. Using the 1314 high back on April 7th a -10% dip would take us back to 1182 or about -104 points lower than our close today. That would be a huge move and one that I do not think we will see over the next two weeks. I believe it will come after the earnings dry up not before they get a running start. If I am right that means the current dip would be buyable but I worry about the very negative internals.
The markets were priced to perfection as we ended March with most of the indexes either hitting new highs or holding near recent highs. The Dow has fallen from 11325 to near 11050 today but could still have farther to fall. Without a significant event to break this trend it seems likely we will test 10950-11100 and possibly this week. The blue chips have proven to be the weakest link but tech stocks are catching up. The Nasdaq had a climax spike at the open on the 7th to 2375 and it has been down hill ever since with the rate of decline increasing. The Nasdaq hit 2302 intraday before an end of day buy program provided some lift. Nasdaq 2300 should be a decent support point. Should that break and a real correction develop the next material support would be 2400. A true -10% correction would be to 2137 but I don' think that is in the cards this week.
The SPX would have to drop to 1182 to break that 380-day streak but I strongly doubt it will come next week. Typically corrections take place after an earnings cycle not before it. That would follow the "sell in May and go away" game plan for many traders. I do believe this May could be the end of the road for this current rally but that does not mean we will be making any new highs between now and then. The current dip may be buyable but only as a trade not as a long term hold. There is far too much concern about an economic decline in the second half of 2006 to support a rally to new highs. It is always possible but a breakout is very unlikely without some new event. This is a holiday week with the markets closed on Friday and typically this is a bullish period. However, Easter is late this year and holiday buying may be distorted by other factors. Saturday is April 15th and the deadline for income tax filing. That always produces some drag on the markets as traders shift cash to pay Uncle Sam.
Dow Chart with MACD rollover - Daily
SPX Chart with MACD rollover - Daily
The "sell in May and go away" best six months of the year strategy popularized by Yale Hirsch the Stock Traders Almanac is also a problem for the bulls. Yale Hirsch discovered several years ago that by adding a MACD to the Dow's chart and starting to unload positions ahead of May when that that indicator showed weakness added significantly to his profits. That indicator turned negative at the end of March and the STA newsletter has been recommending selling into strength for several weeks now. Granted only a small fraction of traders follow this mechanical system but quite a few buy and holders do use it. Using this system since 1950 would have turned $10,000 into $1.411 million. Being out of the market over that period for the worst six months of the year, the six-month period beginning in May would have lost those same investors -$6600 by sitting in cash on the sidelines. You can obviously see why there are quite a few followers to the system. While I don't think this dip is "the" dip I do believe it will appear in May. I warned on Sunday to switch to shorts if the S&P broke under 1295 and I am sticking with that guidance. Keep your stops tight and reenter on the rallies. I think the highs are in but plenty of bullishness remains to give us some nice entry points for summer shorts. The exceptions of course would be energy stocks given the geopolitical concerns. That sector could be a safe haven for those unsure about what the 2006 summer economy will bring.