A jobs number Goldilocks would have been proud of produced a massive short squeeze and a breakout over prior resistance levels on the S&P-500. The Dow soared +138 points to nearly 11600 and the Nasdaq managed to post two consecutive days of gains. It would appear on the surface the bull found new life. With bullishness breaking out all over noted market analysts started predicting new highs. Morgan Stanley analyst Joe McAlinden grabbed his five minutes of face time on CNBC to predict Dow 13,000 over the next 3-6 months. Cramer was busy last week with appearances on Leno, Conan and Meet the Press. Does all this market attention remind anyone of the times past? When the markets and market timers start appearing on magazine covers and the front page of newspapers it is normally time to be cautious.
Dow Chart - Daily
Nasdaq Chart - 180 min
The big news for Friday was the tame employment report. Nonfarm payrolls rose by +138,000 jobs in April and well below the +200,000 consensus. Not only did April come in well below trend but February and March were revised down by a total of -36,000 jobs. February had initially been released at +225,000 and March at +211,000. Both months were revised down to a flat +200,000 jobs. With only +138,000 added in April it brought the three-month average at +180,000 and right in the sweet spot for the market.
The markets wanted evidence the economy was still adding jobs but not at a rate strong enough to cause the Fed to continue its rate hikes. While the top line number may have fallen into that range there were some problems internally. The unemployment rate remained at the cycle low at 4.7% and a level that is considered full employment. The problem came from a sharp +0.5% jump in average hourly earnings. This was the sharpest increase since Oct-2005 at +0.6%. This pushed the gain for the year at +3.8% and the highest pace since 2001. This suggests the competition for jobs is pushing wages higher and wage inflation is a key indicator for the Fed. The jump in wages was even more important given the slow pace of job creation in April. On the bullish side the average hours worked rose to 33.9, which indicates growing demand. Manufacturing jobs jumped by +19,000 and the strongest gain since Nov-2005. The average manufacturing gain since November was only +3,000 jobs. This month's +19,000 represented a very strong jump in the manufacturing sector.
The jobs report should be very Fed friendly since the headline number came in less than the +150,000 required just to absorb new workers coming into the job market each month. However, this has been a strong week for economics and the Fed will have a lot to consider at next Wednesday's meeting. Strong economic numbers came from the ISM at 57.3 (+2.1), ISM Services 63.0 (+2.5), Construction Spending +0.9%, Factory Orders +4.2%, Productivity +3.2% and a -$5 drop in the price of crude oil. These are all very positive events for the economy and the markets. They could also be seen as Fed negative as evidence the economy is stronger than previously expected.
The Fed is widely expected to hike rates to 5.0% next Wednesday but the outlook is very mixed after that meeting. The market is factoring in only one more hike and the hope of a pause after next week's meeting. There is a small contingent of traders who think the Fed may even take a pass at this May meeting. This could be seen as real irrational exuberance.
The Fed is comfortable knowing they have caused a slowdown in the housing market but not an implosion. They want a cooling off period rather than a crash and burn. Toll Brothers announced on Friday that signed contracts for its homes fell -29% over the last quarter and that home deliveries will be 200 lower than previously expected. They will deliver somewhere around 9000 to 9700 homes in 2006 so -200 is not really material. Toll said they were entering the ninth month of slowing sales and that cancellations rose to 8.5% in April. Inventories are currently at 5.5 months of sales but Toll feels like the correction has nearly run its course. New home sales rose +13.8% in March but most see that as an abnormality given the sharp decline in the prior months. If the Fed does stop the hikes in the 5.0-5.25% range then home buying should begin to rise again once rate fears abate.
The Fed is poised to end its hike cycle and over the long term it really does not matter if it is in May or June. The economy is progressing nicely and worries over a second half decline are evaporating. This is being seen in the current market rally. It is not tech stocks leading the charge but cyclicals, materials and commodity stocks. These are clearly stocks, which are benefiting from the first complete global boom in 70 years. All the major global economies are booming and America's multinational blue chips are booming with them. 28 of the 30 Dow components posted gains on Friday with Procter Gamble the only loser and Honeywell flat. The biggest gainers were BA +1.83, CAT +1.17, UTX +1.14, HD +1.03, AXP and Citicorp +1.00. Wal-Mart, IBM, MMM, XOM and JPM were also strong contributors. Financials were very strong with GS +6.35, BSC +3.60, LEH +3.42 and Morgan Stanley (MS) +1.73. For a broad market rally you could not ask for better leadership other than the combination of cyclicals, financials and energy. The Nasdaq finally put two back-to-back gains together to add techs to the mix thanks to the SOX.
While the Dow and S&P hit new five-year highs several others broke out to new historic highs. The Russell-2000, NYSE Composite and the Transports hit blue sky on full afterburner. The chart below should give everyone cause for concern despite the positive fundamentals. The most notable was the transports given the high price of oil. The package shippers, UPS and FDX, are thriving on the global shipping boom. The railroads, CSX, UNP, BNI, NSC and CNI are thriving on strong demand to ship lumber, coal, oil and metals over the entire continent. There is a backlog of railcars on order approaching 40,000 units according to one analyst. The railroads claim the only thing holding them back from greater profits is the lack of those cars. Trinity (TRN) received orders for 12,941 cars in Q1 alone. That was their highest order volume since 1998. FreightCar America (RAIL) said their backlog at the end of Q1 was 17,794 cars.
Dow Transport Chart - Daily
Chart of EXPD - Daily
The strength in the shipping sector can be easily seen by the results in Expeditors International this week. EXPD posted a +24% increase in revenue for the quarter and a +70% jump in profit. Analysts were quick to upgrade estimates and in some cases out to 2008. Analysts were impressed with the jump in their forwarding revenue and profits on that revenue. EXPD jumped from $87 to $107 over the last two days. Even though their results and forecast were outstanding I could not resist buying some puts at the close on Friday because a spike like that is normally unsupportable in most cases.
Airlines are also booming with AMR, CAL, ALK and LCC leading the pack but loads are up system wide. Frontier (FRNT) announced on Thursday that load factors for April hit a record high of 80.7%, up +4.4% from March. Traffic also increased +27% on a +20.1% increase in capacity. Business travel is back and the vacation season is about to begin. Lest we forget those top four airlines are breaking out to new highs with oil prices over $70 a barrel. If oil prices do moderate then airline profitability will rise. Because of my Peak Oil view I refuse to buy an airline stock but somebody is taking those trades.
June Crude Oil Chart - Daily
Energy stocks also participated in the Friday romp despite oil prices stuck at $70. The rebound to $75 on Tuesday was followed by a two-day drop to just below $70 on Thursday after oil inventories showed an unexpected rise of +1.7 million barrels. A guick glance at the chart shows why $70 held. Personally I think the inventory build was a statistical aberration. Oil imports actually fell for the last two weeks but inventories rose. Crude oil imports were down -53,000 bpd and domestic production was down -5,000 bpd. Wednesday's number had to be a result of the refinery maintenance cycle currently underway. Consumption at the 144 US refiners was 15.390 million bbls per day in the week ended 4/28 and up only +108,000 bpd over the prior week it would seem that simple math shows there was something wrong. Refineries received only +756,000 bbls of oil more than the prior week but the EIA inventory numbers jumped +1.7 million bbls. There is a lot of confusion in the market due to the problems with the switch to ethanol and a refinery maintenance schedule that is worse than normal. Refinery utilization rose only slightly to 88.8% last week compared to 91.7% for the same week in 2005. Oil imports were down and refinery utilization down but oil held at $70. The consensus opinion in the market is still $80 before $60. The talking heads were consumed with chatter about falling demand due to $3 gas. Unfortunately that drop in demand will only be temporary. Very few drivers will change their driving habits substantially for more than a few days. Old habits die hard and an average of 1.5 million new cars/trucks are sold in the US every month. Think about it. 1.5 million new vehicles every month just in the US. Only 12% of the world's population has a vehicle. Demand is not going down materially any time soon.
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There has been a surge in hybrid sales over the last month but they are still just a trickle at 21,734 units compared to the 1.5 million conventional vehicles sold. Yes, they will use less gas but until the numbers grow tenfold it is not material in the greater scheme of things. The new Toyota Camry hybrid began to hit dealers lots this week but they cost +$4,500 more than a similarly equipped conventional model. When comparing the savings for 6000 annual miles ($222) of the hybrid (43mpg) to the standard model (28mpg) it would 20 years using simple math to recapture the added cost. Carmakers quote 7-10 years but they must be using a lot more miles per year to make it work. Bottom line for me is that we are not going to become less dependent on foreign oil by driving hybrids as long as 1.5 million conventional cars/trucks are added to the fleet every month. Analysts expect hybrids to reach 4% of the total autos sold, about 60,000 a month, by 2010. I still say it is a drop in the proverbial bucket. Using the April total below those 21,734 hybrids will use 6,209 barrels of oil per month compared to 8,926 for a standard Toyota Camry at 28mpg. The 2,717 bbl savings per month is .0000058% of the nearly 462 million bbls currently consumed in the U.S. each month.
Table of hybrids sold in America
Since my commentary on Tuesday there has been a lot of press about the nationalism of Bolivia's energy resources. Most of the press has highlighted the trend in South America towards the left and the taking back of investments made by large energy companies in an effort to produce energy in those countries. For instance Petrobras invested $1.7 billion in Bolivia since 1997 to build the gas infrastructure that enabled Bolivian gas to be transported and used. Now Bolivia has seized that infrastructure. Petrobras announced on Thursday that they were canceling plans to invest another $5 billion over the next five years to expand that gas infrastructure in Bolivia and would spend the money on LNG projects to import gas into Brazil from other sources. History has shown that whenever energy resources are nationalized that production slows and eventual income to the country decays. But, some have to learn the lesson first hand. Venezuela has been on a nationalism binge for a couple years and the results are bearing fruit. It was announced this week that Venezuela was forced to contract to Russia for 100,000 bpd of oil to supply its Ruhr Oel refinery in Germany. Numerous reports claimed this was due to the drop in production from Venezuela to 2.6 mbpd from the 3.3 mbpd prior to the anti Chavez strike in 2002. VZ production has been declining for several years due to a lack of investment under the Chavez regime. Venezuela was quick to deny the reason for the contract but did admit they bought the oil. With nearly all of South America turning to the left we should not expect production to grow. Venezuela and several other South American countries have turned to China for financing of exploration and infrastructure in exchange for some of the oil produced. I doubt China would take any nationalism of its investments quietly. It also means that any new oil produced will not be heading to the US but to China.
There was a flurry of interest about removing the 54-cent per gallon tax on imported ethanol in order to help consumers with the high price of gasoline. Since Brazil is the number one producer of ethanol and Brazil is friendly to the US it appeared that a possible change was coming. However, the Senate Finance Committee, which would likely review tariff changes, is chaired by Sen. Charles Grassley of Iowa, the largest producer of corn. Grassley was quick to say that dropping the tariff would have little impact on gasoline prices and would harm U.S. farmers. He said "providing duty free treatment for Brazilian ethanol would send the wrong signal to Americans who are devoting their careers to help America become more energy independent." Don't expect any change in the current tariff despite the sound bites from those politicians trying to grab their 60 seconds of airtime. Grassley also pointed out that currently Caribbean nations could ship 269 million gallons to the U.S. before the tariff kicks in and current exports are less than 80 million gallons. That is further evidence that the sound bites are just political posturing ahead of the coming elections.
Iran took another shot at the U.S. on Friday by granting a license to a bourse to trade oil based on euros rather than dollars. Iran said they wanted to free the global market of U.S. influence by removing the dollar as the normal method of payment. Currently oil trading is only conducted in dollars on markets in New York and London. If they are successful and volume appears it would force the conversion of billions of dollars into euros and to some extent force some devaluation of the dollar. Approximately $6 billion of oil is sold daily or roughly $178 billion per month. Obviously not all of it would trade on the Iran bourse based on the Persian Gulf island of Kish but how much would move there remains to be seen. The bourse still has to solve the credibility problems associated with trading billions of euros and guaranteeing the delivery and payment. Since the New York and London exchanges have extreme credibility in this area it would be an uphill fight for Kish. Iran is the fourth largest oil producer in the world and they could jumpstart the process by selling their oil only on the Kish exchange. This is just another bargaining chip in the nuclear standoff currently in play.
Vice President Dick Cheney fired a shot at Russia on Thursday in what will eventually become a global energy war. That will be years into our future but the players are choosing sides today. Cheney correctly accused Russia of using its energy reserves as "tools of intimidation or blackmail" in a speech to Eastern European leaders. He warned that the current backsliding on democratic reforms could harm Moscow's relations with the U.S. and Europe. Russia supplies gas to most of Europe and raised gas prices sharply to Western-leaning Ukraine last winter. This caused a halt of gas supplies throughout Europe. Russia warned last week if it did not get some concessions from other European nations it would divert the gas flow to Asia rather than Europe. This would literally leave most of Europe out in the cold since several nations get up to 40% of their gas from Russia. Russia has renationalized all of its energy assets in the last couple of years and taken back the privatization that was the hallmark of their democracy movement. Now they are warning nations that supplies may or may not be available to them depending in some instances on their political affiliations. Of course they don't say that in print but it is plain truth for anyone reading between the lines. Do not doubt that the world will be fully involved in a war over energy, probably within the next ten years. China and Russia are already preparing for it. One of China's Generals said last year that China expected to be at war with the U.S. by the end of the decade. He may no longer be among the living after making that public statement of fact but it was reported on all the major news services. China currently has 56 submarines including six nuclear subs and has up to 80 more on order. 25 are under contract now, 16 under construction, with two classes of boats being built by Russia for China. The U.S. is currently building only three. Their newest boats are super quiet and can run under water for up to 30 days on battery alone and are virtually inaudible to existing U.S. surveillance technology. They carry Russian SKVAL torpedoes, which can reach 200 knots along with anti-ship cruise missiles. They are not spending these untold billions of dollars just to maintain the status quo! Rant over.
AccuWeather's Joe Bastardi said this week that a much warmer than normal spring in the Gulf was a bad omen for the hurricane season that begins in three weeks. Warmer weather and warmer water tends to produce stronger storms. He also said New York's Long Island and the Carolina coastline face very high probabilities of being hit by a storm due to unusually warm waters in the northwest Atlantic. The Minerals Management Service issued their last report on the 2005 damage this week and it was ugly. According to the MMS they upgraded their number of pipelines damaged from 183 to 457. The number of large pipelines damaged, over 10 inches, rose from 64 to 101. Only 32 of those pipelines have returned to service ahead of the 2006 hurricane season. 113 production platforms were destroyed and only four replacement platforms have been proposed by the operators and approved by MMS. Those four will replace eight and account for 16,700 bpd. The MMS also surveyed the owners of the four largest platforms that were damaged asking when they might return to production. The MMS said 324,000 bpd of returning production was still offline but the three major platforms produce more than that according to numbers from other sources. Chevron was producing 320,000 bpd before the storms but only returned to 200,000 bpd in the first quarter. Chevron said they would never return to pre storm levels because it was uneconomical to restore several platforms and what was restored would be offset by normal field declines. I will end this section on that cheerful note.
The Dow completed its third week of gains and closed at 11577 and the highest level since Jan-18th 2000. This is only -145 points away from its highest close ever at 11722 on Jan-14th 2000. The intraday and all time high on that day was 11750. Needless to say the Dow run has been amazing more for its steady progress than its one-day gains. Only two days saw major gains over the last three weeks, Apr 18th and this Friday. After the March rally topped out on March 16th there were four weeks of declines to retrace to 11040 on April 17th. Since the rebound from that bottom the move higher has been steady with the last two weeks a constant fight at resistance around 11400. That resistance was shattered on Thr/Fri as positive economics sent the blue chips higher. Friday's romp was due to the weak jobs report and the expectations that the Fed was trumped and would have to pause.
The Nasdaq rebounded from two weeks of declines and a retest of 2300 to close just over 2340. This is far from its recent highs at 2375 but it was far better that we have been expecting of late. The tech weakness in the face of a bullish Dow had been very disturbing. The SOX rebounded from 511 to 530 on a sharp jump in semiconductor billings from a -2.2% decline in February to a +2.3% increase in March. Also helping the Nasdaq was a very strong Russell-2000. The small caps literally exploded above downtrend resistance on a 2:PM buy program on Wednesday afternoon and they never looked back. The index gained +22 points from Wednesday's low to Friday's high at 784 for nearly a +3% rebound.
Russell Chart - Daily
SPX Chart - 180 min
The S&P-500, the indicator we have been watching for confirmation for the last couple of weeks showed almost no indications of bullishness for the entire week as of Thursday's close. The SPX remained trapped in the 1300-1315 range until Friday's jobs report. There was a substantial number of sellers sitting on that 1315 level but the jobs report blew right past them at the open causing a giant bear-b-que. It was clearly a monumental short squeeze and once over 1315 on volume the buyers appeared and pressed their advantage. However, it should be noted that volume on both Thursday and Friday was well below the volume from the past two weeks. Friday's volume was only 4.8 billion shares compared to numbers in the high 5B and low 6B range over the last two weeks.
I have been cautioning everyone for the last couple of weeks that the internals were significantly different than the bullishness the Dow was showing. My position recommendation was to remain short under 1310 but to buy a breakout over 1315. I cautioned that a breakout event over 1315 would produce severe short covering and that is exactly what we got. Now, the $64 question is "what's next?"
There are no really earth shaking economic reports next week but the FOMC meeting would trump them anyway. The meeting is Wednesday, which gives the market plenty of time to exhaust its bullishness with a retest of the Dow high at 11722-11750. We have seen many times in the past where a market index had overextended itself in a climax spike to reach a prior high only to implode once that level was reached. With the extreme bullishness we saw in dozens of analysts on Friday it would not surprise me to see that kind of event soon.
The wildcard is of course the Fed. If they did take a pass on a Wednesday it would catch the majority of investors by surprise and could produce another reaction spike. There is less than a 30% chance of a pass according to one bond analyst. More than likely they will raise a quarter of a point to a nice round 5% and then issue a statement suggesting they were on the sidelines and data dependent for any future hikes. Since this is now what most investors expect it should be already factored into the market with Friday's breakout. We could see some follow on buying on Monday after the weekend newspapers talk up the breakout with catchy headlines. But, there is always Fed risk until 2:15 on Wednesday. Until that announcement Fed speculation is just that, speculation. A negative surprise could send us back to 11300 or lower very quickly.
SPX Chart - Weekly
I am going to continue to use the S&P as the best indicator of market strength
despite the stronger performance of the Dow and Russell-2000. I believe those
indexes will eventually track with the S&P. If the SPX holds its gains over 1315
the next major resistance is 1385. That
gives us plenty of running room on a
favorable Fed announcement but I am not holding my breath. The Fed announcement
is now our pivot point and will control our fate. I will continue to remain long
over 1315 until we see what next week brings. I am raising the short signal to
1315 from 1310. Should the SPX fall below 1315 again it could signal a reversal
and a change in trend. If a strong breakout rally like we saw on Friday retraces
all of its gains it is normally a very bad sign.
For now, the trend is our
friend and lets ride this bull until it runs out of steam.