The Nonfarm Payroll report contained a dose of bad news with a headline number that was less than half what analysts had expected. When the April number came in at -37% below consensus on May 5th we had a blowout short covering rally that powered the Dow for +230 points before the FOMC meeting burst the balloon a couple days later. If a -37% miss was good for the bad news bulls then a -56% miss should have been even better. Evidently something has changed in the bullish mindset and changed for the worse.
Dow Chart - Daily
Nasdaq Chart - Daily
The payroll report showed that only 75,000 jobs were created in May and far less than the consensus estimate of 173,000. To make maters worse they revised down the reports for the prior two months by -39,000. Including the revision this report showed net creation impact of only +36,000 jobs. This is the lowest level of job creation since Oct-2005. Despite the low job creation rate the unemployment rate sank to 4.6% and a level not seen since Dec-2004.
Job Creation Table
On the surface it would appear the economy is slowing faster than expected. It takes a minimum of 150,000 new jobs per month to absorb all the new workers that enter the workplace each month. New nonfarm payroll additions barely maintained that level from December to March and has declined sharply over the last two months.
On the surface you would have expected this report to be Fed friendly and market positive because it slammed the door on any June rate hike. The Fed funds futures were showing an 80% chance of a June hike on Thursday night and that plummeted to only 44% by Friday's close. You may have also noticed that the markets struggled all day and only barely managed to hold near the flat line at the close. It was hardly a show of bullish enthusiasm for a pause in the rate hike cycle.
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Obviously there were some extenuating circumstances. The unexpected drop in consumer confidence/sentiment, slowing retail sales, imploding housing market, rising inflation and now a sharply declining job market suddenly became a strong dose of reality. Everyone has been talking about a slowing economy in the second half but up until now there was no real evidence. The second half slowdown has suddenly leaped forward into Q2 with GDP estimates falling to something in the +2.0% to +2.5% range or only half the 5.3% rate we saw in Q1.
Now the fear is not that the Fed will raise rates again but that they may have already gone too far. With the economy plunging back to earth like a spent booster rocket there is substantial fear that the post Katrina rebound only provided an artificial economic bounce for an economy that was already slowing. Now that the bounce is over there are rising fears of a hard landing. Remember, we have at least 9-12 months of further impact from rate hikes already in the system.
Over the last two years investors have been conditioned to buy bad news as Fed friendly but there was another piece of the jobs picture that helped spoil the party. The Household Jobs Survey, which is the self employment jobs and non payroll jobs, jumped +288,000 for May. There should have been cheering in the streets but this survey is not widely reported. For those paying attention it caused them to question the new expectations for the Fed to pause. Payroll jobs creation is shrinking but entrepreneurs are springing up under every roof. This is very positive since many will grow and begin adding employees very quickly. On the surface it appeared the Fed would be forced to pause but there was just enough confusion added to the slower economic signals to cause investors to scratch their heads rather than click their mouse.
Factory Orders for April were also released on Friday and fell -1.8% compared to a gain of +4.0% in March. It was the weakest number in three months. This was actually a smaller drop than the -2.3% analysts had expected but still a drop. The durable goods component fell -4.4% while non-durable goods rose slightly at +1.2%. We saw similar evidence of economic slowing in the ISM drop to 54.4 from 57.3 on Thursday. This is even more confirmation that the economy is slowing more quickly than anticipated and evidence suggesting the Fed should pause in June.
Pulte Home added to the economic gloom and doom on Friday when it warned that orders had fallen -29% in April and May. Pulte operates in 27 states and reported that orders fell from 9,128 units to 6,447 units. Toll Brothers (TOL) also reported a -29% drop in orders for the quarter and Hovnanian (HOV) reported a -19% drop. Pulte said buyer demand had been weak and cancellation rates for the two-month period jumped to 27.4% from 14.8%. While this information makes sensational headlines it is important to realize the context. 2005 was the best year ever for new homes. One analyst said on Friday that despite the drops 2006 could still be the second best year ever. Yes, all things really are relative.
Meanwhile the National Association of Realtors pending home sales index fell -3.7% in April following a decline of -1.3% in March. The April number is -11.7% below last years levels. This index is captured from signed contracts and leads the existing home sales index by about two months. This suggests June existing home sales will be down sharply. Should the Fed actually take a pass at the June meeting it would stimulate a new buy cycle.
Chicago Fed President Michael Moskow was quick to down play the payroll report and the sudden switch by analysts to a pause in June. He said, "We look at dozens and dozens of indicators and take them all into consideration, you can't take one report and say the result will be no hike." His hawkish comments earlier in the week on CNBC had roiled the market and Friday's comments helped to confuse the issue again. Moskow played his energy card again saying the full impact of high energy prices had not filtered through the economy and that impact could push inflation higher over the next several months. He is an inflation hawk and never misses a sound bite to lobby for a 1.5% inflation target. The current inflation rate is 2.1%.
The FOMC minutes on Wednesday had already confused traders with the revelation that the Fed discussed everything from a pass to a +50 point hike at the May meeting. It does not build up confidence in the markets bias for a pause knowing that the Fed even discussed a +50 point hike. The FOMC members were openly dismayed that inflation had risen more than expected. Most had expected it to remain tame or ease. The market does not like it when the Fed is confused and the committee admitted it was uncertain bout "how much, if any, further tightening was needed."
The bond groupies needed no help in making their decision. Bonds were bought heavily pushing the yield on the ten-year note down to 4.994% from Thursday's high of 5.143%. In bond terms this is an extremely large move and one that has bearing on the June Fed decision. The close at 4.9% puts the yield under the current 5.0% Fed funds rate. If this yield remains under 5.0% it would make it very hard for the Fed to raise rates at the June meeting. By raising rates they would be inverting the yield curve even further and that would produce additional economic worry. The Fed box is getting tighter and the heat is rising.
Global market volatility has been extreme over the last three weeks and many have wondered about the underlying cause. On the front page of Friday's Financial Times a headline read, "ECB Warns of Hedge Fund Threat to Stability." The comments from ECB VP Lucas Papademos suggested that hedge funds operating from highly leveraged positions were a risk to global financial security. The dumping of positions in May across several continents could have been the initial stages of an asset shift in response to a global liquidity drain. This liquidity crunch may have started a risk repricing cycle that was long overdue. Large hedge funds borrow at the lowest possible rate and use the funds to leverage their positions. All works well as long as those positions are rising and the borrowing rate remains the same. Once loan rates begin to rise or commodity prices begin to fall the damage can be quick and deadly. He theorized a continuation of the May dumping could trigger an even steeper decline as funds were forced to sell to remain liquid. What we saw over the last two weeks could have been the beginning of a global margin call with commodity investments as collateral.
If Moskow was concerned about energy prices producing inflation early Friday morning he must be in a panic this weekend. Oil prices soared to $72.80 in after hours trading after gaining +2.36 during the regular session. Geopolitical problems were cropping up everywhere and Iran was at the top of the list. In case you had not heard Iran refused to even consider halting its enrichment program and took several verbal shots at the U.S. and UN council for even suggesting such an impossibility. Did anybody even remotely believe that Iran would rush to shutdown its program so it could sit across the table from the great satan and discuss politics? If you did suffer from that delusion have yourself committed at once. As I wrote to the LEAPS Trader subscribers Wednesday night there was no chance in hell of that proposal being accepted. It was pure propaganda and very well played by Condi Rice. The U.S. gave Iran a seat at the world table but that seat was an electric chair for all the good it would do them. It would be the equivalent of putting out an open invitation for Osama to speak at the UN on human rights. It would be suicide for him to show up just like it would be political suicide for Iran's president to suddenly close up his nuclear shop after preaching its benefits almost daily for the last six months. He would lose what little credibility he has and could find himself out of office and his appendages cut off very quickly.
The quick and adamant refusal to even consider the terms of the proposal helped fuel speculation that the door was closing on a peaceful conclusion to the problem. The US warned Iran that their available time to make a decision was only weeks not months. Oil prices shot up on fears that any escalation of the situation could bring about some use of oil as a political weapon. Whether Iran played the oil card in response to sanctions or started mining the Strait of Hormuz the results would be the same. $100 oil would result in a matter of days. Also pushing prices higher was news of eight foreigners kidnapped from an offshore rig in Nigeria. 500,000 bpd is already offline in Nigeria and rebels are continuing their assault. This came just days after Nigeria said production of the 500,000 bpd would resume over the next several weeks. It appears that date will be delayed again. There were also additional refinery problems with Valero cutting gasoline production -50,000 bpd and distillates -20,000 bpd as a result of a fire earlier in the week. Valero had thought the problem would be resolved quickly but it appears it could take an additional ten days or more. Corpus Christi harbor was closed to shipping traffic after a lightning related oil spill at the Valero refinery dock. Lightning also hit Valero's Delaware City refinery causing several units to go offline. These units are expected back up shortly. The Flint Hills refinery and a Citgo refinery also suffered some outages due to mechanical problems and power outages. Dropping power to a refinery kills production for several days because all the processes have to be restarted. The refining process is continuous. Kill one process and everything stops. Each must then be restarted in the proper sequence before production can be resumed.
The OPEC meeting ended with no production cuts but some very angry OPEC ministers. Hugo Chavez went out of his way to make numerous political speeches, some criticizing the other OPEC members, and calling them slaves to western greed and consumption. OPEC goes out of its way to remain politically neutral and a friend to all. They are the shopkeepers for the oil market and angry buyers don't make good customers. OPEC just wants to sell oil and collect the money where Chavez just wants to put the screws to the US. I doubt OPEC will be meeting in Venezuela again in my lifetime.
Crude Oil Chart - Daily
The oil inventory levels on Thursday showed a smaller than expected build in gasoline in the EIA report and a -1.1 mb drop in the API report. Crude rose about +1.6 mb in both reports. The smaller than expected build in gasoline put the levels at -2.7% lower than this time last year. Gasoline demand over the last week spiked ahead of the holiday buying to near the levels seen last year when gasoline was 70 cents cheaper. Those warnings of demand destruction due to price appear to be fading. The inventory levels and demand numbers reported next Wednesday will be critical. If demand remains as high as I expect it should continue to provide support for crude as we enter hurricane season. A quick check of www.nhc.noaa.gov shows storms have not yet begun to form but we are only four days into the season. The NHC is predicting 13-16 named storms with 4-6 major hurricanes. In 2005 a record 28 named storms including 15 hurricanes were reported.
Gasoline Demand Table
I am sure you have heard all the descriptors for the monthly results for May but I will repeat some here. It was the worst May in six years for the Dow and Nasdaq. It was the worst May for the S&P-500 in the last 22 years. You have to go back to 1984 for a worse performance. The good news is that May is over. The bad news is the economy is crashing and the summer doldrums are just ahead. I have to admit my bearish bias is growing but the contrarian result would be a major rally ahead to embarrass me in public. It is no secret I am not bullish and so far the markets are doing about what I expected. The S&P is still wandering in its expected range between 1250-1295. If anything I would have to say there are some bullish signs returning to the NYSE Composite and maybe the Russell. Those positive internals and minor gains could be just the influx of month end cash so we will look forward to next week for additional directional signs. At this point I don't want to have a bias. I need to be neutral. This is the point on the calendar where sudden false summer rallies can breakout BUT the negative economic climate could be an anchor that prevents it this year.
The key for me is still the S&P as the indicator of market strength. On Tuesday night I suggested buying any further dips to 1250-1255 for a trading bounce. We did not quite get to 1255 with only a 1259 low on Wednesday morning. That was close enough for me to reverse to longs in anticipation of a month end bounce. We got the bounce and a nice run back to the 1290 range where we stalled on Friday. 1275 was a potential failure point but after holding just over that level for four hours on Thursday a closing buy program gave us enough lift to cause shorts to cover. Friday's action saw only a +2 point gain after a decent two-attempt failure at 1290 at the open. After struggling all day the index returned to try again at the close. I believe we are poised to make another attempt on Monday, possibly to even stronger resistance at 1295. I would short any failure in the 1290-1295 range.
SPX Chart - Daily
Now, here is where it gets fun. If by chance the bad news bulls return, emboldened by some analysis they read in the weekend paper, we could see a breakout attempt towards 1300. I would be a BUYER on any beak over 1300. This could setup a flood of short covering and produce a bear-b-que. I would be extremely surprised if this occurs but that is the fun part. The bears would be more surprised than me and that could produce a race to higher ground. This is the reason I want to maintain a neutral bias for next week. We are approaching strong resistance but there was just enough positive signs on Thr/Fri to suggest the bulls are trying to sneak into the greener pastures under cover of bad economic news. Fortunately there are no major economic reports next week. The calendar is sparse and those reports scheduled are mostly filler. There is a heavy calendar of Fedspeak next week so be prepared to endure countless mind numbing dissections of every phrase.
The reports we should be worried about next week are earnings warnings. While it is still a little early in the cycle we are approaching the initial window for Q2 warnings. Since most of the stock news recently has not been especially positive I am expecting a strong warning cycle for Q2. Summer warnings are never fun since news is thin and volume thinner. A couple stinkers and we can get some acceleration to the downside pretty quickly.
Friday Market Internals
A quick recap of the major indexes shows the Dow stalled under strong resistance at 11275 after two tests two days apart. A break over 11275 targets 11425-11450 but I would not hold my breath. It would be a nice trade but a better setup for the next summer decline. Current support is 11200 followed by 11100. The Nasdaq closed right on strong resistance at 2220 but has just enough bullish tilt to make me think we could see another leg up to 2250. Tech stocks seem to have found favor with summer investors and we saw a slow but steady rise back to 2220 beginning at noon on Friday. Initial support is 2200 followed by 2165.
The Russell screeched to a dead stop at strong resistance at 742 Friday morning and it could not repeat the attempt the rest of the day. I was trading the Russell futures and it was crazy. There were spurts of large volume but it was equally split on both sides of the market. It turned out to be chop city and a day I should have been fishing instead of trading. I did notice several times that the Russell was weaker than the S&P and that suggests fund managers were not throwing month end cash at small caps. This should not surprise anyone since blue chips are considered safe havens in times of economic distress whereas small caps are considered a minefield.
NYSE Composite Chart - Daily
The most bullish index was the NYSE Composite, which moved slightly above prior resistance at 8285 to close over 8300. This was probably due to the influence of the energy sector, which is well represented in the NYSE. I ran charts on a couple hundred energy stocks with oil exploding and it appears quite a few are completing a saucer bottom and have risen right to resistance with many signaling an impending breakout. With the potential for oil to hit $75 soon as Iran heats up we could see another sprint higher for some of these beaten up stocks. The global margin call or spring correction, whatever you want to call it, saw profits being extracted from many of these positions. Pain at the pump would have been highly preferable to the pain at the broker many of us were experiencing. It may be buying time again for this group.
The transports also posted some gains and broke over resistance at 4735 despite oil at $72.75. If the transports have come back into favor the Dow may not be far behind. I nibbled at CSX again and noticed BNI, CNW, R, LSTR and NSC were leading the sector.
Dow Transport Chart - Daily
SOX Chart - Weekly
The least bullish of the indexes was the SOX with only a minor +15 point rebound off the correction lows. After a -75 point drop a +15 point rebound is positively anemic. I was surprised to see AMD on the verge of collapse at $30. After beating the gigahertz out of Intel in the server chip market I was surprised to see their gains evaporate. I saw some speed comparisons between AMD and Intel chips last week and I was shocked to see such an imbalance in AMD's favor. After a -$5 drop (-14%) in only 10 days it appears their 15 min of fame has faded.
Okay, a quick refresher. There will be a test on Monday
from 9:30 to 4:PM. Short
a SPX failure in the 1290-1295 range but be ready to go long on any breakout
over 1300. Check the oil service sector and oil drillers for potential breakouts
from saucer bottoms if oil prices continue to rise. After a +$2.80 gain in oil
on Friday I would normally expect some profit taking so be ready to buy a dip if
it appears. Support is $70. The ISM Services Index is the lone economic report
due on Monday at 10:AM with an expected drop to 60 from 63. Be
endless economic chatter and a new round of sound bites on Iran. Try to keep
your market bias neutral and follow the trend regardless of direction.