Another price threshold was reached on Friday and that was $75 oil. Unbelievably the equity markets were seemingly unaffected by the news of rising oil until that $75 level was touched. Even more unbelievable was the strong gain for the week in the transports despite the record highs in oil prices.
Dow Chart - Monthly
Nasdaq Chart - Daily
SPX Chart - Daily
It was a surprisingly tame week for economics with the majority of economic reports showing no surprises. The only real surprise and not much of one was the -7.8% drop in housing starts for March. The talk about the bursting housing bubble has been the topic of choice for several months but the size of the March drop was startling. This was also the exact drop for February coming off a +16% jump in January. Starts soared in January as builders loaded up the pipeline for the spring buying season. With a lead-time of 3-6 months from start to ready for sale the January numbers make perfect sense. The -7.8% drop in both February and March was much sharper than expected and suggests builders are not confident enough in future sales to continue building inventories.
The majority of market movement came from the Tuesday FOMC minutes and comments from Fed officials that suggested rate hikes may end at 5.0% at the May 10th meeting. This sent the Dow soaring to new six-year highs and new five-year highs on the S&P. The Nasdaq managed to equal its early April 2375 high but was not able to hang on to those levels. The Dow was helped by strong earnings from the 13 Dow components already reported with a strong boost from UTX, GM, MMM and BA. UTX was up +$7 for the week, BA +4.50 and MMM nearly +6. With those kinds of individual gains it was surprising the Dow was not up even higher.
On the tech side the gains were much harder to make. EBAY dropped -$5 after disappointing the street and sank to a nine-month low at $35. EBAY reportedly is scared of Google and is attempting to form an alliance with Microsoft and/or Yahoo to reduce search exposure to the new Google Base. Google Base is a free classified listing service that could compete with EBAY. Google was the lone standout in the tech sector with a +$22 gain to $436 after Thursday nights earnings. Google appears to have snapped back into investor hearts after disappointing in January.
Further tech troubles came from a downgrade on Dell to SELL by Citigroup. Analyst Richard Gardner cut his rating on Dell on concerns about company growth rates and eroding margins. Gardner said demand for Dell products in the corporate markets and its end user base was slowing and competitors were beginning to erode share away from Dell. Gardner said data released on Thursday from IDC showed that PC shipments from Dell were flat for the first quarter and IDC saw only +5% growth for the year for the entire PC market. Gardner feels Dell will be forced to cut prices to maintain volume and this will reduce profits already stretched thin due to heated competition with Hewlett Packard. I believe that investors should remember that Dell is a very powerful force overseas and that is not counted in the IDC report. Dell sank to a low of $26.78 and a level not seen since March 2003.
Dell was not the only tech player to attract a downgrade on Friday. Broadcom nearly doubled its profits when it reported on Thursday but was hit with a downgrade to "average" by Caris and Company on Friday. BRCM fell -2.19 to close at $43.57 after failing at resistance at $46.75. Broadcom's guidance of +3% to +5% growth was seen as conservative. UBS Analyst Alex Guana warned that it would be difficult for Broadcom to deliver dramatic upside in the future. He said research and development costs were rising and the law of large numbers on sales and a higher share count would make further upside surprises difficult. BRCM just completed a 3:2 split raising their outstanding shares to 524 million.
Sandisk was also a victim of earning news. They announced after the close on Thursday that profits fell -26% and the stock was hammered on Friday for a -$5.49 loss to close at $60. Sales had risen +37% but profits fell as a result of its Matrix acquisition. Results were inline with analyst expectations but traders were hoping for an upside surprise. Sandisk said prices for NAND chips would likely decline -50% in 2006 to further pressure margins. Margins for Q1 came in at 28.4% compared to the company's prior projections of 30-32%.
Intel was also pushed lower after giving a mixed message earlier in the week. Their outlook presented on Wednesday was much lower than previous forecasts but Intel was upbeat about the prospects for later this year. Analysts doing the math are concerned that Intel would have to produce growth of 15% in both Q3 and Q4 to hit their 2006 targets and this is seen as a real challenge if the economy really weakens later this year as expected. Intel had rebounded nearly a buck from its low at $19 but it returned there before the week was out. Intel may have a positive outlook for the rest of 2006 but the outlook for Intel stock is not so rosy. Intel announced that they were reducing capex spending for the rest of 2006 by -$1 billion. This is the kiss of death for chip investors as they feel it is a sure sign of real trouble behind the scenes.
On the biotech side Affymetrix disappointed investors despite a prior warning in February. AFFX dropped -15% or -4.85 to close at $29.03 and a new 52-week low. Profits fell -89% and revenue -25%. This was below the already revised estimates from analysts.
Ford was knocked for a loss on Friday after riding the GM wave higher earlier in the week. Ford posted a -$1.2B loss for the quarter and revenue declined rather than increased as many expected.
On the upside for the week was Travelzoo. TZOO blew away estimates of 14 cents with earnings of 24 cents when every short in the market was expecting them to miss for the quarter. TZOO closed Monday night at $19.88 and just above its 52-week low of $16.50 set back in February. TZOO had been a sleepy stock trading in a tight range with a downward bias since last August. Those days are history after Monday night's earnings. TZOO closed the week at $44.35 for a gain of nearly $25 or +123% for the week. This was the mother of all short squeezes and the stock was still rising into Friday's close.
June Crude Oil Chart - Daily
December Oil Chart - Daily
The real winners from the week were of course the energy stocks. It does not take much imagination to deduce the impact of $75 oil. With gas prices over $3 on both coasts and headed for $3.50 I got several emails complaining that oil companies were simply price gouging. If you have been reading my commentary on the oil sector over the past two years you should know this is simply not true. Oil prices and therefore gasoline prices are not set by the oil companies. Oil prices are set by the 320 or so refineries around the globe, 149 in the US, that actually convert the crude into something we can use. They are forced to buy crude on the open market in what amounts to a bidding war. They do lock in prices by negotiating long-term contracts with suppliers but they get bitten by those contracts about as much as they win. If you were a refiner today and your contracts were expiring what would you do? I doubt you would rush out and commit to 12 months of crude at $75 a bbl. You would be forced to enter into some kind of contract to guarantee a base amount for delivery but the rest would have to be bought in the market where you hoped the prices would soon decline. If they declined to $65 would you contract for delivery for the next two years? Probably not since human nature always expects a lower price since prices have been lower for the last 24 years. Actually the process is a lot more complicated than described here but you get the idea. Refiners must purchase crude to produce products. The price they pay for crude determines the cost of their products. Refiners are not going to buy crude at $75 and sell gasoline at $1.50 a gallon. If anybody is getting gouged it is the refiners with crude breaking record highs every day. They have to buy it, wait for delivery, refine it and then sell it to recover their money. That can be a long process depending on where the crude is coming from.
The switch to ethanol is complicating the process. Refiners, pipeline operators and resellers have to empty tanks with the old MTBE blend and then clean them before reloading with the new ethanol blend. Ethanol shortages have been reported on both coasts and gas stations on the east coast have been experiencing random shortages of those products blended with ethanol. The refiners ran at nearly 100% capacity all last year due to the hurricanes removing several refiners from operation for several months. Now those refiners who picked up the slack are undergoing a lengthy maintenance cycle as they convert from winter products to summer products and repair/replace equipment that was damaged as a result of running at 100% capacity for that extended period. Refiners will eventually catch up with demand but it may take another month or so. That is not the reason for oil hitting $75.
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I started warning readers back in the summer of 2004 that an oil crisis was coming. Oil was trading just over $35 at the time. Numerous readers emailed me over the next year with all the reasons I was wrong. Oil closed over $75 on Friday and I have not gotten a negative email about my outlook in many months. If you took my year-end recommendations in 2004 your average gain in the stock price would average over 82% each. All but one has produced more than 58% gains with CCJ at +162% and CNQ at +209% the leaders and ARLP the sole laggard at +12%. These were conservative stock plays each paying an average of 4.9% in dividends in addition to the stock gains. The four month gains from the 2005 end of year recommendations, RIG +26%, CCJ +37% and MDR +48% would have paid your subscription price for the next decade on the gain in stock prices alone. Using the recommended options would have doubled or tripled those gains. I am not patting myself on the back for personal fulfillment. Heck, in hindsight I could have done a lot better had I not been so conservative but it is tough to trade on hindsight. I am simply trying to illustrate that my outlook was correct and sticking with the program will produce real rewards. Oil is going higher and you can count on it. Maybe not next week but it is going higher.
Oil prices are going higher because it is getting tougher to find and we are using it faster. That is the bottom line. Almost all oil not being produced in North America today is in politically unstable geographical locations. Several OPEC countries are either a war zone or about to become one. South American countries are on a nationalism binge, which removes the desire for any oil company to invest money to find and produce oil. By nationalizing their fields they kill the geese laying the golden eggs and end up watching their production slow to a crawl as fields decline and mechanical parts begin to wear out. History has proven this over and over.
A lot of the speculation going into the $75 price today revolves around problems in Nigeria and Iran. The UN Security Council is expected to get the next IAEA report on Iran sometime next week and that fire is likely to heat up. I watched a really good program on the History channel this week, "Is Iran the Next Iraq." It profiled the history of Iran's nuclear ambitions and laid out perfectly clear the pattern of deception Iran has used to defeat the inspection process. Did you know that the latest nuclear lab was built 150 meters underground in a mountainous region to prevent it from being bombed from the air? The US has said it may have to use a nuke to destroy it. Did you know that 20 antiaircraft sites have been recently installed around another site? Russia is in the process of selling Iran 29 sophisticated Tor-M1 air defense missile systems for $700 million. Russia also said on Friday they saw no reason to impose sanctions or freeze sales of military hardware. Surprised? China also made noises that suggested they would not agree to sanctions. The stalemate by Russia and China increases the chances of an American intervention of some sort. Did you know that for the last 25 years there has been an anti American rally in Tehran that thousand of people attend every Friday after prayers. On Friday President Ahmadinejad praised the high oil prices and said he hoped they reach their real value soon. (higher) He also said that Iran was taking steps to rely on domestically produced gasoline to reduce their exposure to possible sanctions. Iran imports some gasoline because they lack sufficient refining capacity. This is not going to end peacefully but it may take many more months for the process to wind its way to conclusion. As long as there is the possibility of sanctions or an attack on their nuclear facilities there will be volatility in oil prices.
At $75 crude is primed for some profit taking. I believe the ramp up last week was more the result of the rollover from the May contract to the June contract and option expiration than from geopolitical concerns. Oil prices should continue to trend higher on falling gasoline levels but that should be temporary. Crude levels in the US are at an eight-year high and once the refineries come back online the pressure should ease. I shorted the crude futures at $75.25 on Friday and held it over the weekend. I also bought puts on the Dow Jones Energy iShare (IYE). These are just temporary trades but after the gains in energy stocks last week I felt a strong need for a hedge against disaster. Energy stocks tend to cycle about once a week on profit taking and last Friday was the last real blip. The two Friday's before that were also dips. That sets up Monday as a potential profit point given the lack of a material dip in a week and the psychological $75 level. But, as several energy traders said on CNBC Friday the momentum players are loading up for summer and higher highs tend to attract new buyers. Bottom line, continue to buy the dips but watch out for a real correction as we move into May and the gasoline levels begin to build. Also watch the news as we near next Friday's IAEA report on Iran. That could be a market mover. Did I mention that the 2006 hurricane season starts just over four weeks from today?
I mentioned earlier that the markets were oblivious to rising oil prices until that $75 level was touched. The reason for ignoring the crude reality is simply the global explosion of growth. According to one study released on Friday every major country on the planet is seeing growth. We have not seen this since 1969. Many are spending their oil wealth like Azerbaijan and Angola both with 26% growth for Q1 but the non-oil countries are also firing on all cylinders. China announced +10.2% growth last week and India is approaching 8% but their Prime Minister said they were targeting 10%. Russia just posted +7% and many of the large economies are growing comfortably at +4-5%. For this reason the price of oil has not been a factor since most feel this spike is just a blip in the trend and business is booming. It will eventually come back to haunt us as demand destruction due to price will slow global growth. However, although $75 is high it is below the inflation adjusted high of $97.55 we saw back in April 1980 according to the Wall Street Journal. Personally I think comparing oil prices in 2006 to those in 1980 is a fools errand but it keeps the bean counters busy.
The problem with the markets is not going to be oil prices although oil may be blamed. I believe the spike to new highs last week was simply a short squeeze similar to TZOO but only on a larger scale. Earnings are coming in very strong. Over 30% of the S&P has reported and 69% beat their estimates. No challenge there but traders were expecting good results so after the big spike there was no place to go. 13 of the 30 Dow components have reported and those 13 were the ones with the potential to move the markets the most. You are not going to get the same bang for the buck when the others wander in over the next couple weeks. Traders are more likely to take profits in those Dow components with monster gains than push them higher chasing prices into the summer. This leaves the Dow isolated and hovering just over the prior support at 11300 as May rapidly approaches.
The Nasdaq continues to have trouble with 2360-2375 and tech earnings have not been as good as the blue chip companies we saw last week. There have been a few standouts but a few stinkers as well. The bloom is off the rose for techs and there is greater earnings risk as we continue through the earnings cycle to the progressively smaller companies. The SOX had two really good days last week to bounce it off support at 500 and hit a new two-month high at 535. That excitement faded quickly as sellers took advantage of the bounce to exit before the summer doldrums appeared. The SOX closed the week at 518 after giving up -50% of its bounce. The Russell stalled at just over 775 and a new historic high, but momentum faded and we saw it pullback to 770 twice late in the week. It appears exposed and vulnerable at this level. The +35 point rebound from the prior weeks 740 low was very strong but looked suspiciously like short covering rather than new buying. I would short any drop under 770.
The real key to market strength this week appears to be the S&P. 1310 has proven to be a tough level to crack and hold since first touched back on March 16th. We have sprinted over it several times only to fall back into the 1295-1310 range the next day. The S&P closed at 1310 on Friday after a +35 point ramp from just over 1280 that started on Monday. To be perfectly honest I was surprised it held that level. I expected it to collapse at the close but a late afternoon buy program, probably related to option expiration, rescued it from the 3:15 lows at 1306.
SPX Chart - 120 min
Gold Chart - Daily
I told you last week that I expected some selling to appear towards the end of
April. I suggested shorting the rallies as we got nearer to May. I believe last
week's short squeeze was a gift and we may have seen the highs for the quarter.
The bull made one last break for the fence as the truck from the slaughterhouse
at the barn. It was a valiant effort but I doubt he will escape. We may
equal the highs again next week but I would be very surprised if a breakout
appeared. I would be happy to buy it but I am not counting on it. My
recommendation for next week would be to get short on any dip under S&P 1310 in
anticipation of some profit taking in May. With oil prices over $70 the
potential for continued Fed rate hikes is increased. High oil prices will
eventually push inflation higher
and the Fed will have to raise rates over 5% to
combat that inflation. The next Fed meeting is May 10th and with oil spiking the
talk of higher rates should begin again next week. The yield on the ten-year
note topped at 5.5% last week and that is very tempting as a safe haven over the
summer with talk of an economic slowdown in the second half of 2006. I have
heard traders talking about a 6% yield before the Fed meeting and that would be
a death knell for stocks. I know my outlook may
not be as rosy as everyone would
like but you pay me for my opinion not a rosy picture. At least if we prepare
for the worst and it does not come we can be pleasantly surprised.