The day started off quietly and remained subdued for most of the day. While the equity market closed down (except for the NYSE), it was not a high-volume sell off. It seemed more a lack of interest in buying the market today which could have been the result of oil back in the news as it climbed above $70. Or it could been a hangover from the long weekend and traders came back watching instead of participating. This being opex week we can expect a little more volatility than what we saw today.
Prior to this morning's open, Citigroup (C 48.25 +0.30) announced their earnings which exceeded analysts' expectations for $1.02 per share by earning $5.64B, or $1.12 a share, compared with $5.44B, or $1.04 a share, a year ago. Their upside surprise shouldn't be a surprise anymore after we've seen what the large banks are doing in their market trading operations. As Michael Mayo, an analyst with Prudential Equity Group, wrote in a note to clients, "The main negative is ongoing pressure in U.S. consumer, especially given spread compression, and private banking sluggishness." During the latest quarter, U.S. card revenue fell 6% to $3.23B from $3.46B for the same period last year. U.S. consumer lending dropped 8% to $1.26B, down from $1.37B, and U.S. commercial lending dropped 31% to $470M from $678M for the year-ago period. Citigroup also authorized a share buy-back worth $10B. This would of course improve the per share earnings results.
I had written a few weeks ago how the Fed has signaled the banks to tighten up on their lending criteria since there was too much risk to the banking system. This is achieved by sending in bank examiners to study and re-grade loan ratings as necessary. One of the first areas to get hit as a result of this is commercial lending, including commercial real estate. By Citigroup's numbers above you can see this is already having an impact.
But offsetting the lending business for Citigroup was record fixed income markets revenues of $3.15B, up 8%, which reflected "broad-based performance across products and regions, including record results in emerging markets trading, municipals, and credit products." Compared to the fourth quarter 2005, fixed income market revenues increased 51%. They also experienced record equity markets revenues of $1.18B, up 67%. These profits were a result of "strong growth globally, including cash trading, derivatives, and convertibles." Once again, without these trading results, the banks' performance would be reflecting the truer state of their business, which is down. But thanks to their "low-risk proprietary trading systems" they're able to rake in the cash. I just wonder who's on the losing side of those trades.
JB Hunt (JBHT 22.89 +1.38) reported first quarter net was up $49M, or 31 cents a share, +3.1%. Revenues were up 10% to $779.9M. Analysts had been looking for EPS of 31 cents on revenue of $788.7M. JBHT says they continue to see robust demand for their services. As I'll show in the chart of the Trannies, their may be some holes showing up in the dike and the picture may not be as rosy as JBHT believes.
The two economic reports this morning, both before the bell, were the NY Empire State Index and Net Foreign Purchases. The Empire Index fell to 15.8 which was the lowest since October. It fell from a revised 29.0 for March. The decline caught economists by surprise since they had been expecting the number to drop to only 24.5 from the initial estimate for last month of 31.2. All major subcategories fell in April, with unfilled orders dipping below zero. But it was a case of bad economic news is really good news since a slowing economy is really good because the Fed will become less aggressive about raising rates. I'll say it again--it's a fallacy that the market should expect the market to rally once the Fed stops raising rates. The strong odds are for a market to be down significantly 6 and 12 months after the Fed stops tightening. The market will rally when the Fed makes that announcement and that will be your signal to sell all your holdings and get short.
The Net Foreign Purchases of U.S. securities jumped up in February to $86.9B, 26% above January's upwardly revised number. Foreign purchases of U.S. Treasury notes and bonds were up huge--a 5-fold increase to $21.9B.
These numbers didn't move the market this morning and other than a quick pop up in the morning, it was pretty much down hill for the rest of the day. We'll have to see if the afternoon bounce into the close will turn out to be anything more than a corrective bounce.
DOW chart, Daily
On the verge of breaking down, that's what I see here. The DOW has now broken both its October uptrend line and its 50-dma. It can easily tolerate a 1-2 day break but not much more and it shouldn't dip much further than it has if it wants to cling to the hope of rallying back up. If it gets much further below that uptrend line and 50-dam, both will become resistance. But as we saw in January and again in February, the 50-dma break was not a killer. But each time the break only lasted 2-3 days so we'll just have to watch this one to see what happens. If the break is for real we could see a trip down to its 200-dma but there's lots of layered support between here and there. The shape of the decline from the March high still leads me to believe the DOW hasn't finished making a market high which is what I've depicted on the chart. I'm still hanging onto that thought until we see a firmer break down, especially a break below the March low of 10922.
SPX chart, Daily
The SPX has the a similar picture to the DOW except a little more bearish in the respect that it has more significantly broken its October uptrend line, more in time than price amplitude. But now with a close below its 50-dma as well, it sets a bearish tone to the chart. If there will be another leg up, as depicted on the chart, the pullback must stay above the March low of 1268. If a high is in, we should see the SPX work its way down towards its 200-dma at 1248, which will probably be closer to strong Fib support at 1253 by the time it gets there.
Nasdaq chart, Daily
The COMP has the best chance of getting another leg up when viewed on this chart. Support by its October uptrend line and 50-dma was tested today but not broken. As long as this 2297 level holds I would try the long side (scalpers only). You can keep a stop relatively close just underneath (just watch the stop runs). If the DOW and SPX are not able to hold support though, I don't think the COMP will either. In fact the QQQQ gives me the impression the techs are breaking down.
QQQQ chart, 240-min
Breaking down from its bear flag pattern looks bearish. This is a 240-min chart so it's hard to tell whether a candlestick pattern will follow through or not but that last candle is a bullish looking hammer so a green candle would be confirmation of a potential turn back to the upside. That's something to watch here since the larger pattern leaves me with the impression we're going to see the techs continue lower.
SOX index, Daily chart
The SOX looks bearish and has looked bearish ever since it started its bounce off the March low. This index looks like it will head to its 200-dma at 486 (which is also 50% retracement of the October-January rally.
Market Risk, Part I
We often talk about market risks but many times we really don't know what that means. I came across an article by John Mauldin that had some very interesting information that I thought would be worth forwarding to you in the form of a synopsis (otherwise it will be too long and as it is I'll cover the material in two parts as I think it's a fascinating study about our current market condition and why I believe we're at risk for a significant "dislocation" as some like to call it. I call it what it is--a market crash.
The gist of what Mauldin was talking about came from a book titled "Ubiquity, Why Catastrophes Happen", written by Mark Buchanan. The basis of his book was a study of chaos theory, complexity theory and critical states (sounds pretty heady but supposedly the book is written in layman's terms) and the study was done in a unique way. Three physicists, Per Bak, Chao Tang and Kurt Weisenfeld, wrote a computer program to simulate the building of sand piles one grain at a time in order to study the effect of adding these grains of sand and watching the resulting avalanches (the so-called "dislocations"). The grains of sand would be "dropped" randomly at different locations which built up random piles. They learned that the time of the next avalanche could not be predicted, nor where it would occur. Some dislocations would result in only a few grains letting go and sliding down the hill. Other avalanches were cataclysmic and would take down the whole mountain.
While they were unable to determine when or where a dislocation would occur, they were able to identify what they called "fingers of instability" which were areas of non-equilibrium. These were the areas that were identified as vulnerable to an avalanche (by the steepness of their slopes, size and proximity to other vulnerable areas). Their work clearly has some use in the study of earthquakes and many other areas where chaos theory is part of the study. But what, you may ask, does this have to do with the financial markets. This is where their identification of these fingers of instability can help apply this theory to what's happening in our markets and why it's important to think about the potential risks we face as the market faces its own avalanche potential.
In the computer model they were able to show that a grain of sand falling on an area identified as one of the more vulnerable sand piles could cause a cataclysmic avalanche. But it was hard to predict whether a break would occur and what effect it would have. If an initial hill slide touched off other slides in nearby hills and finally hitting the most vulnerable hill it could cause a complete collapse in an area far removed from the grain of sand that started the whole thing. The closer the fingers of instability, the greater the chance for a domino-like reaction whereas if the fingers were small and separated there was less of a chance for a failure in one area to affect another area. With the fingers plentiful and close together the risks grew enormously for a collapse to occur. As the sand piles grew and the fingers of instability became more numerous and close together the "system" reached a critical state.
Thinking about our financial markets it's not difficult to relate this study. Our markets have become enormously complex. We share data at light speed, have a myriad of trading vehicles, most of which are highly interdependent and linked to other financial instruments. Everything in the sand piles above, as it reached critical state, looked stable. All the grains of sand were sitting there, nothing was shifting and it looked like nothing would happen. Add one more grain of sand and it was the proverbial straw that broke the camel's back. Simply stated, and not to offend the pure physicists out there, the critical state is that state when there is the opportunity for significant change to happen from a small disturbance.
An example of a recent event that highlighted a critical state was when a small third-rate paper in Denmark caused riots around the world when they published a small cartoon of the prophet Mohammad. The Muslim world is a powder keg and highly sensitive to what the western world is doing and thinking and is quite likely feeling very defensive if not insecure. It can be thought of as at a critical state. Road rage could be thought of as a critical state. Why else would someone driving down the road react in such a violent way when in any other similar situation a one-fingered salute would have been the extent of the reaction. It's usually a sequence of events that led up to the "avalanche" and the final trigger was unpredictable, again both in the time of the event or its magnitude.
The other piece of this chaos theory is that the period just prior to some cataclysmic event was marked by stability. In other words there was nothing to identify its instability and therefore there was no warning that something bad was about to happen. The sands dropped randomly onto their piles left piles of sand that looked very stable and it was only after an avalanche took down the whole mountain could you go back and identify the grain of sand that started the collapse and see what it triggered and how it caused a domino reaction through the system of sand piles linked together. It is this stability that brings us to our current market condition.
Many have reported on how stable our economy and markets have been. This is a good thing but it can also be deceiving. Even Greenspan talked about this in years past, about how long periods of stability can be deceiving and lead to periods of instability. Paul McCulley, with PIMCO Bonds, has written extensively about the inherent dangers we face because of the deceptive stability in the markets. We see it in equities when we look at things like the VIX. There is no fear in the present market because the market has been so stable for so long. Whether it was because of the "Greenspan put" or just because people have a fundamental belief in the system, the bottom line is that people are not afraid of the market.
One of the consequences of this is that we're seeing historically low returns associated with the perceived low risk. But it's like our cars--the safer they make them the faster and more recklessly we drive because we feel safer in them. Look at how many 4-wheel drive SUVs and trucks you see turtled in the median the first snow fall we get. They think they're safer and drive faster in icy conditions and then find themselves unable to stop any better than the other cars. We now have a market driving full speed down an icy highway in their top-heavy SUVs and haven't tested the brakes yet. One small emergency ahead of the market could get us careening into the median where we'll flip upside down and wonder what the heck happened.
So this is our setup to the critical state of our market. On Thursday I'll wrap this up with a discussion of why we're at a critical state and more importantly an example of what could come out of left field that leaves us flipped upside down. It will only take another grain of sand in the wrong place and the ramifications could ripple through the financial system and cause an avalanche. It's a time for caution in the market, and for protection. The bull market has had a good run and we know a correction (of something at least 10%) is long overdue. The stability we've seen is a setup for shock and awe in our market and squeezing out the last penny of the bull market could end of costing you a lot more pennies than the penny you might have gained. Cash is good.
Moving on to the banks, we want to keep an eye on them as they continue to be a good proxy for the market. The ability of the banks to hold up, or not, should be our canary in the coal mine and one we want to watch. They'll sniff out interest rate problems and a slowing economy early enough to give us a heads up.
BKX banking index, Daily chart
If we're to use the banks as our canary, it's looking a little wobbly as though it's starving for some oxygen. It's threatening to break its October uptrend line and closed just below the 50-dma. So far it's confirming what we're seeing in the DOW and SPX. If we see them diverge that will be a heads up to watch for a change. If they stay in synch, whichever way they go, we will have confidence the move is probably a reliable one. For now we'll watch this closely to see if it really breaks down or not.
The home builders index came out today and showed a drop to 50. The views by many showed a split between those thinking that was half good and half bad. That's the old argument about the glass being half full or half empty (to which an engineer will respond that the glass is simply twice as large as it needs to be). For only the third time in the past 10 years, home builders are as likely to say the construction market is "poor" as they are to say it's "good." The reading of 50 is the lowest level since November 2001 and is a drop from 67 a year ago. The survey shows builders are somewhat optimistic about the current sales climate and about sales in the next six months. But the traffic of prospective buyers at developments isn't hopeful. As was noted in the report, the rise in mortgage rates and price increases have now priced many prospective buyers out of the market. The market has also seen the withdrawal of speculative buyers. This is what I've mentioned many times in the past few months--once the speculators leave the market, and worse, start dumping speculative homes, that's when the excessive number of homes on the market will start to depress home values even further.
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In April, the index for current sales of single-family homes fell from 59 to 54, the lowest since November 2001. The index for future sales of single-family homes fell from 62 to 58, also the lowest since November 2001. The index for traffic of prospective buyers fell from 40 to 39, the lowest since March 2003. The numbers "are neither surprising nor alarming," said David Seiders, chief economist for the builders' industry group. A reduction in speculative buying "is a positive development," he said. "Furthermore, we expect solid growth in employment and household income to essentially offset the minor increases" in mortgage rates projected this year. Clearly a half-full kind of guy. With household income on the decline for the past 8 years, I'm not sure why he believes we're going to see an increase this year. And if we do get an increase you can bet the Fed will all over it out of worry about wage inflation and they'll be boosting interest rates 0.50% at a clip. That would not be at all helpful to mortgage rates. But hey, I want those rose-colored glasses he's wearing. I'll be they look really cool.
U.S. Home Construction Index chart, DJUSHB, Daily
The home builders came down and touched their long term uptrend line at 852. This is a very significant trend line so a break below it (for more than a day as it did in March) would be very telling. Until then we should look for a bounce off support here. If bonds continue rallying, as they started to today (dropping yields), we could see the home builders get that bounce.
Oil chart, May contract, Daily
Oil's rally above $70 (May contract whereas the June contract, which will become the front month at the end of this week, topped $72 today) is "credited" with today's equity decline. Rallying to new highs has caught the attention of traders and this time the worries over geopolitical risks are getting the blame and that of course depresses the market as they're forced to recognize the higher risks. The consolidation pattern that I think we're in, an ascending triangle playing out since August 2004, can't tolerate much more of a rally in oil before negating it. It can tolerate a small throw-over but much more than that and it will look like the next rally leg is already well on its way. Until that happens, I'm still expecting to see the pullback depicted on the chart.
Oil Index chart, Daily
Oil stocks could be telegraphing the next move, which is the one depicted on the chart. By not making a new high with oil, the oil stocks could be telling us oil is peaking here. If so, we should see both start their pullback and the stocks should pull back in a choppy pattern to the 200-dma/uptrend line currently near 543.
Transportation Index chart, Daily
The Trannies have layered support with first support tested today--its October uptrend line at 4570. Next would be its 50-dma at 4497. It would take a break below its March low of 4489 to indicate we probably made a longer term high, if not THE high. One step at a time but I'm beginning to think a more important high has been made. It came within spitting distance of the 4771 Fib target and that could certainly be considered close enough (within 0.2%). If stochastics actually makes into oversold that could also be our first clue that a more significant decline has started.
U.S. Dollar chart, Daily
The US dollar got hit hard today and it broke below its shorter term uptrend line, the one identifying a potential sideways triangle pattern. It broke below but barely recovered above the $88.50 level but I'm thinking too late, the damage has been done. I'm thinking the dollar is going to sell off. But it could save itself and jump back above $89 and stay contained within the coiling pattern. We'll see but it's not looking good after today. Comments out of Chinas suggesting their central bank would scale back their dollar-based asset accumulation is what initially hurt the dollar. Remember, China is currently the largest foreign holder of US dollars at the moment, just under $900B. That's why I was saying John Snow needs to make nice with the Chinese. Don't bite the hand that feeds you. The Net Foreign Purchases, as reported in the beginning of this report, helped stabilize the dollar after its early plunge.
Gold chart, June contract, Daily
With the dollar down we saw a rally in the commodities index and gold, silver and oil were right there with the rest of the commodities. The spike in gold and silver looks suspicious. I've got a wave count that calls for the current leg up in gold to be finishing the rally from July 2004. If true we should see a multi-week pullback. I've been expecting this for a while and clearly missed the additional rally potential but now the weekly negative divergence showing up at this new high is a warning--protect profits and be ready to play the short side if you're a nimble trader.
It's always a dangerous game to short these spikes but the move smells like a blow-off top to me. If the dollar does recover tomorrow I suspect we'll see a hard pullback in these assets. After the hype for the new ETF for silver (SLV), and the stories about shortages in silver that will be created, this is the perfect environment for a blow-off top. I would not want to be a buyer of silver here, no way. Even if it runs another dollar, the risk is too high in a parabolic move like this:
Silver chart, July contract, Weekly
If this were a stock, would you be interested in buying it? Silver has a habit of doing this. I'm using the emini contract for this since the chart of the full contract, SI, has too many bad ticks on the chart. Notice the run up in the 1st quarter of 2004 to just above $8. It then gave back $2.56 of that in 4 weeks, a 31% correction. The current run up dwarfs that last "little" spike and a 30% correction from here would give us more than a $4 correction to back under $10. I think I'd wait before thinking about adding the ETF to your portfolio.
Results of today's economic reports and tomorrow's reports include the following:
Tomorrow could see some reaction to the morning reports. If the numbers come in line with expectations there probably won't be much of a reaction. We don't have a market that's perched on the edge or anything like that so we shouldn't have a jumpy market. But obviously housing numbers and PPI have the ability to move the market and all those reports will be out before the bell. Likewise, the FOMC minutes likely will not have anything the market doesn't already know but watch for a market reaction at 2:00 from that.
The internals for the market today reflected the down day. Even though the NYSE ended the day in the green, thanks to an early morning pop higher which wasn't full retraced this afternoon, the internals reflected a more negative day which matched price action in the other major indices. The low volume though makes any market move suspect, especially during opex week. What doesn't look good though are the number of new 52-week lows as compared to new highs. I had mentioned last Thursday how the new highs-new lows curve is beginning to round over which it hasn't done since last October. This measurement usually reflects accumulation and distribution and right now it looks like distribution. It's just another signal from the market that you should be very cautious about long positions.
Sector action was mostly red today, again reflecting the major indices. The few green sectors were the gold bugs index (HUI.X), energy, disk drives, securities broker (thanks to China Construction Bank making an offer to purchase a stake in Bear Stearns) and a couple of small financial indexes. The red sectors were led by the airlines, computer hardware and other tech, SOX, healthcare, Transports and retail.
I noticed Intel (INTC 19.19 -0.26) got pounded back down after looking like it was going to finally break out of its doldrums last Friday. It dropped to a low of $18.99 today. INTC announces earnings after the bell on Wednesday and it appears traders are nervous about what they'll say. If that nervousness continues in stocks in general tomorrow, watch for any early pop to get sold off again, just like it did today. The bounce in the broader market this afternoon has a corrective look to it (overlapping highs and lows initially) and therefore gives me the impression that we'll see the decline continue tomorrow morning. It could set up a reversal Tuesday though where a new low finishes the decline from last week and we'll start at least a larger bounce back to the upside. As I showed on a few charts above, it's even possible we'll see the start of a new rally leg. That would certainly catch a few bears napping.
This is opex week so be careful of whipsaws and lack of follow through. Today was surprisingly smooth in its sell off. We didn't get hit with any program buying spikes that knocked traders around. I'd sure like to see more days like that. But tomorrow could change so be ready for some buying to come into the market. Just when the bears get comfortable in their short positions, thinking we've finally broken support, is when the program buyers love to hit it and get that short covering fuel driving the market higher. Whether that starts out of the gate tomorrow or after another new low to suck in a few more shorts, or whether the buying will even kick in at all, it's too hard to say. I've seen it happen too many times and think it'll hit us again tomorrow. Be ready for it. Good luck and I'll see you on the Monitor.